I am a strong proponent of thinking about common stocks in the same manner as private businesses without the benefit of control over the business. It's a great way to transfer the focus of investing from the price of a stock to the performance of a business. Namely, if I were to purchase a car wash for $250,000 that made a $30,000 profit in my first year of owning it, I would spend my time deploying the $30,000 in profit intelligently and trying to increase the car wash's overall profitability level each year. But most importantly, here's what I would NOT be focusing on: trying to find someone to pay $275,000 or $300,000 to take the car wash off my hands. When I buy shares of a high-quality company that is publicly traded, I apply the same thought process as if it were a private business that I owned: I check to make sure that the profit stream in the form of cash dividends is poised to grow over time at a rate greater than inflation, and I make sure that the earnings growth of the company also appears to grow at a rate greater than inflation.
I made the personal decision that I wanted to go through my financial life planting financial trees all over the place while monitoring whether the growth comes at a satisfactory pace relative to my personal expectations. That might mean planting a $4,000 Coca-Cola (KO) tree here, and a $4,500 Johnson & Johnson (JNJ) tree over there, and as time passes, I measure my personal success by monitoring the current earnings and dividends generated by a company relative to the cash investment I had to make. I'm emphatically not measuring my success by whether or not I can get someone to take those Coca-Cola and Johnson & Johnson trees off my hands at a higher price than I paid -- I want to continue to reap the benefits of the harvest each year for myself!
If I invested $3,500 into Chevron (CVX) in 2003, I could have purchased 100 shares of the oil giant. For me, that's my car wash. I regard my Chevron ownership the exact same way as if it were a private business. I didn't buy a part ownership stake in the oil giant just so I could try and sell it to someone else for a higher price. I'm focused on the retained earnings and cash dividend checks that I receive over time relative my initial purchase of the investment. In 2003, those 100 shares would have paid out $143 in annual dividends while earning $348 in total profits. With 2012 winding to a close, it's expected that those same 100 shares for which I paid $3,500 are now going to generate $351 in annual cash dividends and $1,225 in total profits. For an outlay of $3,500 in 2003, I receive a 10% cash dividend in 2012 (not to mention all the quarterly cash dividends that got paid out from 2003 to 2011) with annual earnings representing roughly 35% of my initial investment in 2003.
When you can identify two or three dozen companies that appear likely to raise earnings and dividends by a rate greater than inflation each year, and then buy them at a reasonable price, you can then sit back and make sure that the trees are growing at a satisfactory pace. I reject the notion that wealth-building is about the need to be always "doing something." How many times have you turned it on CNBC in the last week to hear the commentators bring in the experts to tell you what you need to buy and sell to position yourself for the fiscal cliff. A month ago, they were telling us what to buy based on whether Obama or Romney won the election. If the ebb and flow of world events is causing me to alter my strategy, I believe I'm doing something wrong. Just as I wouldn't sell my car wash company because of the fiscal cliff, presidential election results, or whatever the next attention-grabber may be, I wouldn't sell my Coca-Cola or Johnson & Johnson stock just because of some adverse global news story that might make other investors want to pay less for the companies I partly own.
The transformative effect of treating your common stock holdings like private businesses is that this strategy encourages you to focus on earnings growth, dividend growth, and the overall health of the business without worrying about the price that someone else would be willing to pay if you sold your ownership stake. For instance, Johnson & Johnson has raised its earnings and dividends every year through the financial crisis and through today. The price of the stock, meanwhile, has been all over the place in the past five years. If you focused on the price of your Johnson & Johnson stock, there could have been plenty of moments in the past couple of years that might make you want to sell your stock. But when you approach common stock investing with the attitude of a private investor, the focus on earnings and dividend growth can make it much easier to regard the fluctuations of the stock market as the irrationality of others.
Disclosure: I am long JNJ.