This article marks my 24th for Grainews. My first article, in March of 2018, had a quote: “it’s all about buying common shares in solid companies, and holding them for a long time.” I hope you are now convinced of the validity of this approach.
Why is this simple strategy shunned by most market participants? Why does Warren Buffett fill an arena for his annual meeting, then when everyone goes home they virtually all ignore his advice and return to their trading ways? The average holding time of a publicly traded company in the U.S. was over five years in the 1970s and has declined to under eight months today. The average market participant (speculator, trader and investor) turns their portfolio completely over 1.5 times per year. The average market participant also underperforms the market by four to five per cent, achieving about half of overall market returns.
Market participants have taken to heart Mark Twain’s famous quip, “Never let the truth get in the way of a good story.” They continually ignore the facts, preferring whatever the current short-term story-line is. Currently it is about markets at all-time highs and that valuations are expensive. The first part is clearly true, but what about the second part?
Bank of Nova Scotia and other Canadian banks have fairly consistent earnings, as well as a consistent policy of paying about half their earnings as dividends, making them ideal for this illustration. Ten-year bond rates are a good indication of overall interest rates and a leading investment competitor to stocks. In 1993, Canadian 10-year bond rates were about eight per cent and BNS was paying about five per cent making BNS’s dividend rate about 0.63 of the 10-year bond rate.
Today BNS has a dividend yield of 4.7 per cent and 10-year bonds are about 1.7 per cent. BNS is paying an income stream about 2.75 times larger than a key competitive investment product. Even though BNS is valued slightly higher than in 1992, having a slightly lower dividend yield, relative to interest rates it is valued four times better (2.75/0.63). I would sooner buy shares in a Canadian bank and collect four to five per cent dividends that have a habit of doubling every 10 to 12 years, than lend money to the bank (or government) with a two to three per cent static yield. When you deposit money in your bank account or buy a bank GIC, you are lending the bank money. When you buy a government bond you are lending to them.
Since 1963, the 10-year U.S. bond interest rate has averaged 6.2 per cent. Today it is just 2.5 per cent. Long-term average earnings yield (earnings/price) of U.S. stocks is 6.7 per cent, similar to interest rate averages. Currently the earnings yield is 4.5 per cent, indicating above-average stock valuations, but the earnings yield has not declined nearly as dramatically as interest rates (6.7 to 4.5, versus 6.2 to 2.5). Historically stocks spend one-third of their time within five per cent of all-time highs making the current situation fairly normal.
The Canadian market is cheaper. Our current average earnings yield is about 5.7 per cent and our 10-year bonds are only 1.7 per cent. Higher earnings yield and lower interest rates are indicative of a lack of confidence in our economy, but should support stocks when confidence returns.
Short-term, stocks can move unpredictably either direction, but longer-term I would argue against the story-line that stocks are expensive. Stocks might be a little more expensive than average, but interest rates are a lot cheaper than average.
As an amateur investor with a day job, I don’t have time to turn over my portfolio 1.5 times per year. That level of activity would drive me crazy. The secret to my success and sanity has been ignoring the flavour du jour and the currently touted story-lines, while picking solid companies and holding them for long periods. Have I mentioned that already?