Focus on Income, Not Prices

 

(Please note: The following article is from Joe's book, Easy Investing, Abundant Income. Share prices mentioned in this article reflect the market in late 2004. Current prices are: Commonwealth Bank $39.30, National Australia Bank $29.11.)

A major barrier to investment success is an obsessive focus on share prices.

The second biggest barrier is the belief that if you own shares, you have to watch the market every day and buy and sell all the time.

If you focus on the income your shares generate for you, both of these problems disappear.

The price means nothing, by itself.

Every single day I speak to novice investors who tell me that Commonwealth Bank shares (for example) just have to go down, because $30 per share is too expensive, and besides, they’ve risen from less than $10 just a few years ago.  (People also said this at $15, $18, $20, and $25, and no doubt they’ll keep on saying it.)  This sort of thinking is nonsense.

The price of Commonwealth Bank shares or of any other share is driven by these factors:

--the dividend paid on the shares
--expectations about future dividends
--perceptions of the stability of the company’s earnings
--a premium or discount based on the mood of the market
--the market's assessment of the quality of a company's board and management

Let’s consider each of these factors:

Dividends--If the Commonwealth Bank is paying a dividend of say $1.80 and the share price is $30.00, the dividend yield is $1.80 ÷ $30.00 = 6.0%.  If you invest $10,000 in CBA shares today, you expect a dividend return which, initially, will amount to 6% of the purchase price, about $600 per year.  

Whether or not this is reasonable depends mainly on how much you would receive for your money elsewhere.  It happens that as I type this (in late 2004) 6.0% is a higher rate of return than you would get on most cash deposits, so you’re certainly not missing out by owning Commonwealth shares.  (Also remember that because of the franking credits attached, the dividends are worth far more than interest income.  Be sure to see the important chapter on dividend imputation.)

Expectations--If people expect future dividends to be higher, they’re willing to pay more for the shares which will deliver these dividends.  This clearly would push the price higher.  A gloomier outlook would pull the price lower.  At any given time there will be investors who expect the outlook to improve and those who expect it to deteriorate. The market price reflects the net view of all different investors.

Earnings Stability--This refers to the market’s perception of the reliability of a company’s earnings.  Such companies as Woolworths, Foster’s, and Telstra are regarded as having high quality earnings, because people will keep on buying goods and services from these companies pretty much regardless of what happens in the economy at large.  

Equally well managed companies such as Qantas have less reliable earnings.  In a slow economy, business people may travel less, and everyone can defer or skip an overseas holiday.  In a pinch, people can get by without Qantas far more easily than they can get by without Woolies or Telstra.  None of this is to say anything bad about Qantas, but you have to recognise that Qantas’s earnings are less reliable, so the market will probably demand a higher dividend yield in compensation.

Market Mood--When markets are running hot, investors seem to like every share.  They’re often willing to pay too much.  In gloomy times, some people can’t envision a recovery, so they’re willing to sell their shares for far too little.  For this reason, shares are sometimes too expensive and sometimes too cheap.  In the long run, prices are pulled back in line with the dividends a company pays.

Board and Management--The market places more trust in the management of some companies than others.  A company which produces steady, predictable results with few nasty surprises will be more highly regarded than an accident-prone company whose board members engage in public brawls.  Even a company with a long successful history will see its share price fall if the market loses faith in the board and top brass.  As I write, the National Australia Bank is suffering from this very problem.  On its actual results, NAB's share price should probably be higher, but it's presently trading at around $27.  This is because board members have engaged in public battles which have caused many to believe that the board is more interested in restricting board control to the old-school Melbourne elite than it is in running the company properly.  Sooner or later NAB will emerge from this shameful spell and the price will move ahead when it does so.

You don’t have to trade

Most investors do best by buying good shares and then leaving them alone.

There are opportunities to make money from trading, but these are for people who are willing to treat their portfolios as a full-time job.  Most people have neither the time nor the information to do this effectively.