Key insights
- The post reinforces the value investing principles of Peter Lynch and Benjamin Graham, emphasizing the long-term correlation between a company's earnings and its stock price. It suggests that while short-term market volatility exists due to emotional trading, stock prices tend to revert to levels supported by underlying earnings. The analysis of sample businesses supports the idea that deviations from the earnings trend are often corrected over time, implying a potential buying opportunity when prices are below the earnings line and a selling opportunity when prices are above.
A couple of days back I made a post about how you could evaluate a business (You can find the post here). Because I like reading a lot (not only this subreddit) and I've found many posts claiming that those people have issues understanding business fundamentals or how you should construct a portfolio of individual stocks. I'd like to go further on Peter Lynch's topic.
Peter Lynch said:
"I don't think people understand there's a 100% correlation with what happens to a company's earnings over several years and what happens to the stock.
Also Benjamin Graham said something similar:
"In the short run the market is a voting machine, but in the long run, it is a weighing machine"
Share prices can and will be volatile over a period of time. This comes from human psychology. People trade or invest with emotions. You might know the phrase "buying high, selling low," but it actually should be the other way around. People are often carried away by "the FOMO syndrome" pushing share prices higher or lower which are mostly not backed by fundamentals.
I could makes this into an essay and create a large post just explaining. But let me show it to you with examples. Does earnings truly correlate with the underlying share price of a business?
I only showed 6 businesses, which should be plenty. You'll always see the exact same pattern:
- The businesses follow the earnings line like it's sticked to it with glue 2. If the business its stock price trade above the earnings line, eventually the price comes down 3. If the business stock price trade below the earnings line, eventually the price goes up 4. When the earnings go flat or down, most of the times, stock price will stay flat or go down.
So, Peter Lynch was onto something when he release his book back in the '90s. And it is still applicable today. It's a shame that most people don't make the effort to read those books. It's a small investment which could give you potentially very high returns.
A slight note on this. This doesn't work on every business. It only works with businesses that:
- Have strong (future) growth * Are predictable and are profitable * Have high ROE and ROIC * Investing in low ROIC business can also be profitable * Have a moat and are capital light * Pay an intrinsic price that is below the market price or undervalued
Keep away from businesses that are in commodity or have high capital requirements like banks. Most people don't know how to evaluate them. I stayed away for many years from oil but I saw an opportunity with Occidental in 2024 and I took the gamble. Which is paying off right now.
There are plenty of businesses to choose from with the above requirements. You only need a couple of those businesses to become wealthy or generate enough income to not rely on society. These requirements are not only for large cap businesses. You can find many small to mid caps that are as good as the large caps. The only thing they lack is a proven track record for many, many years on end.
If you have plenty of time and you like reading, please read this blog post. I am not affiliated with this post. It's a post I came across dating back from 2018. The writer did a great job covering a lot of quotes about this topic from the best investors of our times.