Investors are constantly inundated
with the latest regional conflict, political debate, economic data and interest
rate predictions. All of this information represents the collective viewpoint
or “consensus” of investors at any given point in time.
Over the many years we have spent
studying the markets, the truest thing we know is that the consensus is already
priced into the market... and the consensus is almost always wrong. If an investor
believes the economy and earnings will be better in the future, they will
“vote” with their money. In aggregate, all of those votes create the price
level for a particular stock. If the consensus comes true, you won’t see much
of a change in the markets and prices will generally drift sideways.
What changes the price of stocks
are the things that the consensus doesn’t already expect. Therefore, the only
way to make excess risk-adjusted returns is either:
1) Find where the consensus is
wrong.
The Consensus View
At DCM, we stay current on the consensus
for lots of different reasons, but we base our decisions on something else.
Before we share that with you, we wanted to give you what we believe is the
current consensus among most institutional investors and major research
firms:
- Economy
The economy will continue to improve, but growth will be less-than-optimal
in the near-term. Employment numbers will continue to grind higher, but nothing
outstanding is on the horizon. The weather is to blame for the lackluster
economic data that has been coming out over the past few months.
- Inflation
Perhaps the strongest consensus of all is that inflation will continue to
be below the Fed’s target rate of 2%.
- Earnings
The weather has negatively impacted both the economy and earnings.
Consumers held off purchasing goods and services during the abnormally cold
winter, which negatively impacted 4Q 2013 numbers. The pent-up demand from
delayed purchases will muddy earnings growth in both 1Q and 2Q 2014. It may not
be until 3Q 2014 that earnings numbers reflect a more accurate picture.
- Interest Rates
Most investors believe that long-term interest rates will rise during the
remainder of 2014 and continue to do so in 2015-16.
- Outlook for Stocks
The consensus among investors is that stocks (specifically U.S. stocks)
are the best place for investment dollars to be right now. Bonds don’t offer
much return in exchange for the risk of rising interest rates, which has forced
many income-seeking investors to dividend-paying stocks. As the economy
continues to muddle along and interest rates stay muted, the consensus outlook
for stocks remains modestly favorable.
Our View
- Earnings
The consensus is that earnings growth will be less than previously expected to start the year. We disagree. Our view is that earnings growth will meet expectations. Dividend growth in the 1st part of the year has been above our projections. Since dividend increases are voluntary, we believe that reflects corporate America’s view that - even in the face of bad weather - the earnings that they projected at the beginning of the year will be there by year-end 2014.
- Interest Rates
Most investors believe interest rates will rise over the next three years. We also believe rates will rise, but less than the consensus and not in a straight line.
Looking Outside the Box
Most investors spend 80% of their
time and energy observing and predicting retail sales, the economy, interest
rates and whatever is going on in Russia. While it’s certainly important to
consider how events may impact stocks or sectors, that’s not the most important
factor.
As investors, we aren't buying Fed
policy, housing data or stock prices - we are investing in companies. Cummins,
Inc. doesn't build interest rates, they build truck engines. Procter &
Gamble doesn't care about Vladimir Putin as long as people around the world
continue to buy diapers, paper towels and razors. Johnson & Johnson can’t
determine what happens in Washington, but they can focus on increasing their
share in many healthcare markets. If investors see themselves as part owners in
these companies, the focus on increasing market share and earnings begins to
drown out the political jockeying and speculation about rising interest rates.
So the most important question of
all is: what are the companies we are investing in concerned about?
The fact is, companies don’t worry
much about any of the things we mentioned above. Of the companies we own, there
probably isn't a single CEO that wakes up in the morning and thinks about what
Republicans or Democrats are going to do. They probably don’t have much of an
interest in what Janet Yellen has to say. Unless they are direct business
partners with a country in turmoil, they don’t worry about global conflicts.
Companies and the people who run them focus 95% of their time on:
- Customers - How can we provide a more valuable product or service?
- Competition - What can we do to increase market share?
- Cash Flow - What is the most profitable place for our free cash?
- Costs - How can we become more efficient, reduce costs and increase profit margins?
What Are Companies Doing?
Our Dow Jones Industrial valuation
model, which we have spoken about repeatedly over the years, is primarily
driven by the dividend. That model has predicted about 90% of the annual
movements of the DJIA over the past 50+ years, which means only 10% of price
changes can be attributed to the random noise.
Even though the dividend is so
clearly important, most investors don’t pay any attention to it. They get so
distracted by the headlines that they completely miss out on what really
matters. The stock market already knows all of the things that they think they
know. They should be focusing their time figuring out what the company is
doing. And the best indication of what a company is doing with their business
and how confident they are in their business is to look at what they are doing
with their dividend.
As we’ve said many times before,
dividends represent real cash payments to investors. Once a company begins
paying a dividend or increases it, they must maintain those payments forever or
their stock price will suffer greatly. If a company raises their dividend, that
means they are confident in their ability to produce adequate cash flow to
continue paying that dividend for many years to come.
If you want to know where the stock
market is headed, here’s what you should do. Go grab a copy of the Wall Street
Journal, but don’t pay any attention to the headlines. Flip right on past page
2, 5, 10, and 20. Keep digging until you find the page that tells you what
companies are doing with their dividend payments. Now tear that page out and
post it right behind your computer monitor or beside the coffee pot.
When you’re concerned about
whatever the consensus is concerned about, just remember that it’s all just a
bunch of noise. If you want to succeed as an investor, focus on what the
companies you own are doing. If you want to know what they are doing, go grab
your tear-out of the Wall Street Journal and check what the dividend growth has
been.
When you get there, you’ll see a
very different picture than what you see on the news or read in the paper. Over
the last 12 months, dividends have grown by 10.6%. In the 1st quarter of 2014,
dividends grew at a significantly faster annualized rate than the 1st quarter
of 2013 - indicating that dividend growth could rise above 10.6% in 2014.
Companies can see well beyond the consensus and, as their dividends clearly
show, they are confident in the future. Regardless of what’s on the news
tonight or in the paper tomorrow, one thing is as true today as it’s been for
the past 50+ years: so goes the dividend, so goes the stock.
DISCLAIMER:
Owners, employees, and clients of Donaldson Capital Management own shares of
CMI, JNJ, and PG.
