27 August 2020 | Eugene Ng | Founder & CIO | Vision Capital
A chat with an old friend sparked this article. He had been doing venture capital investing in more than 30 different companies all these years, and is successful. He is now able to recognise certain things he looks out for almost immediately without a blink of any eye, if such an investment is likely to do well or similarly not do so well. As he rightly outlined, pattern recognition is key to sporting success as do in many fields.
I operate in a slightly different field, investing in publicly listed equities. I probably have spent close to the magic countless 10,000 hour mark outlined by Malcolm Gladwell reading annual reports, doing countless company and industry research. Indeed as my old friend mentioned, similarly pattern recognition starts to really kick in after a while.
Here are some long-term patterns that immediately come to my mind when it comes to investing.
(1) The stock market is a voting machine in the short-run and a weighing machine in the long-run.
The following chart compares the S&P 500 index with its trailing twelve- month (TTM) earnings per share (EPS) value back to 1935. As you can see, the S&P 500 always moves higher along with higher earnings, but at times, the S&P 500 may rise higher (massive rallies) and may decline much lower (market sell-offs). Always remember, the market is a weighing machine in the long run, not a voting machine. In the short run, market prices can be higher or it can be lower.
Source: Yardeni Research (Jun 2020)
(2) Rising stock prices tend to follow rising revenues.
Below are four charts of Amazon’s Trailing Twelve Month (TTM) revenues versus its stock price on a max chart, a 10 year, 5 year , 3 year chart on a normalised basis.
Initially, the faster revenue growth was leading Amazon’s stock price, but then the stock price started to grow much faster than revenues.
(3) Rising stock prices tend to follow rising profits.
Below are four charts of Amazon’s Trailing Twelve Month (TTM) profits (i.e. Net Income) versus its stock price on a max chart, a 10 year, 5 year and 3 year chart on a normalised basis.
Net Income continues to grow faster than stock price increase.
(4) Rising stock prices tend to follow rising cash flows.
Below are four charts of Amazon’s Trailing Twelve Month (TTM) Free Cash Flows versus its stock price on a max chart, a 10 year, 5 year and 3 year chart on a normalised basis.
Free cash flows lead to stock price increases.
Don’t be bothered by Charts like this
I hope with this article you will no longer be bother by charts like this below. What is too high, has to be seen in a longer time context, with pattern recognition. Don’t be blinded by financial headlines stating that Amazon prices hit new record highs, leading you to think that Amazon’s prices are already so high and that it can no longer go higher. Understand why, how and what you invest. Do not invest in company because someone tells you it can go higher, do so because of the right company fundamentals.
In Summary
Go beyond the chuff, find out the underlying drivers that drives these companies and you will come to invest very differently.
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