One of the most beautiful, and often underappreciated, circumstances for long-term investors occurs when the prices of high-quality companies fall while the earnings and dividends of each share grow. As those familiar with Dr. Jeremy Siegel's research can tell you, The old Philip Morris (MO) (PM) was the best performing American stock from 1925 to 2003, posting annual returns of 17%.
An interesting reason why Altria performed so well during that period goes beyond the successful growth of the business alone. To be sure, the old Philip Morris did churn out ever increasing gobs of cash for shareholders, but that was only one part of the equation. The low valuation of those old Philip Morris shares (due to the ever present risk of litigation and declining smoker rates) is what made the cigarette company's long-term outperformance possible. Long-term investors tend to do poorly if falling prices are coupled with anemic earnings growth or dividend cuts, but when a firm is maintaining 7-12% earnings and dividend growth while prices fall, we can participate in a favorable environment that turbo-charges returns by allowing reinvested dividends to buy a greater amount of profits due to the lower price.
This comes through in different ways. Successful long-term investing is often about buying the greatest amount of future profits at the lowest risk-adjusted price. That's why I feel baffled when I hear from readers who declare that the ConocoPhillips (COP) stock spinoff from last month is a failure because the price didn't skyrocket shortly after the split (and these folks complaining about Conoco's performance in the past month could very well be the same people who consider themselves "long-term investors" in the abstract). Let's see how much the earnings and dividends grow between now and 2020, and then we can have an intelligent conversation about the long-term merits of the stock spinoff.
Other times, some folks will point out that companies like Johnson & Johnson (JNJ) have moved "nowhere" over the course of the past decade, as if this is evidence of a problem with Johnson & Johnson's business model. That's a bad way to look at long-term investing. After all, you could have paid $64 for a share of Johnson & Johnson in 2004, or you could pay $62 per share now. In 2004, those shares represented $3.10 in profits and $1.10 in dividends. In 2012, that same ownership stake could buy you about $3.63 in profits and $2.40 in dividends. Today, shares of Johnson & Johnson give you more earnings and dividends at a lower price than 2004. It's the job of Johnson & Johnson management to come up with strategies that lead to earnings growth and enable continued dividend growth for the shareholders of the business, but it's our job as investors to determine a rational price to become an owner.
If you're a day trader, short-term investor, or speculator, it is easy to see why these declining stock prices could make you a wreck. But there's another path-it doesn't have to be that way. If you buy companies with long-term records of earnings and dividend growth that, according to your research, appear poised to continue earnings and dividend growth going forward, then you can isolate yourself from the mayhem in the market and even come to enjoy it. It seems to be a reasonable expectation to anticipate that Exxon Mobil (XOM) and Chevron (CVX) will be earning more money (and paying out more money to shareholders) in 2017 than in 2012. When you own those types of companies, stock price declines can become a boon to your investment returns because the dividends reinvested can buy more shares in declining markets, which will provide more income down the road for the patient investor.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.