In reviewing the history of automotive part distributor Genuine Parts Company (NYSE:GPC), I happened upon some timely insight. Now I'm not sure if you've heard or not, but stocks are on fire. 2013 turned out to be a record year for Wall Street, with both the S&P 500 and Dow indices having their best return performances in the last 15-plus years. Moreover, the S&P has racked up 5-straight positive years with near 20% annualized returns depending on the way in which it's calculated.
As such, stock prices "must" go down this year, right? After all they are "due," and buying now would only indicate that you're foolishly chasing past performance. Perhaps you caught my subtle sarcasm just then. As you know, I never proclaim to know the direction of the market, but I would like to bring some rational thought to the table.
A common argument against equity purchases right now - other than the idea that they are "due" to decline in price - is that many companies are trading both at record prices and towards the higher-end of the valuation spectrum. True enough, but I would advocate that neither idea is exceedingly insightful.
To the point of record prices, it should be made known that 52-week high numbers aren't especially telling. For instance, I have previously described how the SPDR S&P 500 ETF (NYSEARCA:SPY) hit a new 52-week high no less than 480 times in the past two decades. Given that companies tend to make more money over time, even constant earnings multiples would indicate the need for continuously higher prices. So if someone tells you that a company hit a new 52-week high, that's hardly a reason to avoid the stock - you need more information.
Now the second argument - the idea that many companies are trading at higher valuations - is a bit more compelling. After all, we all know that better returns can be had by consistently purchasing securities at lower valuations. However, I believe a distinction should be made here: it does not necessarily follow that partnering with companies at higher valuations is a sure way to find failure. As you are about to see in my real world example, even paying up for quality companies can provide you with reasonable results over time.
So what does all of this have to do with Genuine Parts? Well that's a good question and I'm glad you asked. As depicted in the 1994-2004 F.A.S.T. Graph below, you can see that GPC was able to grow earnings at a modest pace during this time and the price more or less fluctuated about the "normal" P/E of 16.1.
Given this scenario, with a year-end P/E ratio of 19.5 and a price over $44, one might be inclined to believe that caution was the word. The price was at an all-time, and the P/E ratio was much higher than it had been at any time during the past decade. More specifically, the price and relative valuation of GPC in 2004 looks quite similar to many companies today. Companies like Procter & Gamble (NYSE:PG) and Johnson &Johnson (NYSE:JNJ) are at all-time price highs, and the valuations have been steadily moving up. At the end of 2004, an investor likely would have been hesitant to partner with GPC, just as they are now reluctant to add to their PG and JNJ positions.
Yet take a look at what the return results would have been for the untroubled GPC shareholder over the past 10 years:
A hypothetical $10,000 investment on 12/31/2004 - when GPC traded at 19.5 times earnings and an all-time high share price - would now be worth over $22,000. Expressed differently, GPC returned over 9% a year - handily ousting the S&P during this time. Perhaps my expectations are a bit different than yours, but I find it somewhat impressive that 9% yearly returns could have been achieved based on yearly operating earnings growth of less than 8% and a historically high P/E. Granted in the short-term there were lower valuation points, but the ideology stands. Those that thought GPC "must" be trading too high in 2004 might have missed the inherent potential within the long-term effects of a profitable business. The market does many things, but what is clear is that it is not bound by what we think "ought" to happen. Even if one is correct in the short-term, it does not follow that this guarantees success in the long-term. Incidentally, paying a higher price would certainly have been better than missing out altogether.
Whether or not a similar pattern holds for many of your favorite companies today remains to be seen - but the similarities appear eerily similar. When you're buying a stock, you're partnering with a company, which is no different than a deal you would make to buy a house or a farm. Thus you shouldn't care what someone offers to pay you in the coming hours, days, months or even years if you have no intent of selling. Instead, what you should be concerned about is the present arrangement that is being offered on the company's behalf. As depicted in the GPC example, strong earnings, a solid dividend and a longer-term time horizon can make up for paying a bit of a premium.
Now it should be made explicitly clear that I'm not suggesting you should go out and buy GPC today - despite it trading at a very similar valuation point as it did at the end of 2004. Nor am I suggesting that you recklessly throw money at your favorite company, regardless of valuation. (Although there are worse techniques out there) All I'm suggesting is this: the best we can do in this investing world is partner with the best businesses we can imagine at what we perceive to be reasonable or better points. All too often people see the news and negative articles and think to themselves: "gee, the market has gone up. Maybe I'll sit out for awhile." When instead one's thinking should likely be more along the lines of: "What are the prospects of this specific company in a decade or two and does today's price offer a reasonable proposition?" Or expressed using a Niels Bohr quote: "prediction is difficult, especially if it's about the future." As long as the partnership proposal appears reasonable in the coming decades, there's not much of a need to fret over short-term unknowns.
Disclosure: I am long JNJ, PG. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.