Where is the price headed?
It's the 64 million dollar question when it comes to buying shares — and one that we all ask.
Sadly, it's impossible to know — at least accurately and certainly over relatively short time frames. Not that that stops any number of 'experts' offering highly precise and short term forecasts…
But here's the thing; you don't need to know exactly where a price is headed in the near term to do well as a sharemarket investor. Of course, you should have a reasonable idea as to the general direction of the price over time, and it's important to have a sense of the magnitude of any movement, but how do you do that?
Ironically, your best bet is to forget about price altogether — at least in the beginning — and focus on something else entirely.
Consider this analogy…
Imagine there is a man walking a dog. It's a rather hyperactive dog, and is on a very long leash.
The man is walking from Central station to Circular Quay in Sydney. He's moving at a slow, but steady, pace and is heading essentially in a straight line, with only the occasional and relatively brief detour.
His overly energetic dog will, when excited, run well ahead of the man. At other times, when spooked, the dog will fall back behind the man. But most of the time, it will just dash all over the place for no obvious reason.
The point is this: no matter what the dog does throughout its journey, it will inevitably arrive at Circular Quay. After all, that's where the man is headed and the dog is tied to a leash.
In our analogy, the man represents a company's earnings. The dog — as you've no doubt guessed — represents the share price.
Trying to guess which way a dog will run next, based on where it has recently been, is patently absurd. But the sad fact is that that's exactly what most people do.
Let's look at an example.
This is the year-to-date share price performance of our latest income recommendation at Motley Fool Dividend Investor (I won't disclose the name, or price scale, out of respect to paying members).
As you can see, it's not a pretty picture. In fact, shares have lost about 20% since the start of the year.
Most people tend to extrapolate recent trends forward and as such, in this case, would assume that this is a pretty bad investment. But let's zoom out and look at a longer time frame. Importantly, let's ignore price (the dog) and instead look at earnings (the man).
(specifically, we'll look at the trailing 12 months of earnings on a quarterly basis)
Now, does this look like a poor company to you? By the way, this period covers the GFC, a period over which this business saw no material drop to its earnings. Little wonder the business was able to pay a regular and rising stream of dividends over the period.
Given we know what earnings have done, it's not hard to guess that the share price performance has also been pretty attractive — albeit far more erratic.
Given that I expect earnings to continue their upward march in the coming year (as do most analysts), do you think I'm worried by the recent fall in share price?
Indeed, the very fact that shares have fallen has given Motley Fool Dividend Investor members a great opportunity to buy — which is why we only recently recommended it!
Of course, the price could keep going lower in the short term — as I said, you just can't predict these things — but i'm not focusing on the price. I'm focusing on earnings, and that allows for a great deal of confidence!
Foolish Takeaway
Do I know where the price of my shares are headed over the coming months? No, I have absolutely no idea!
In fact, although a have a good sense of what earnings growth will look like in the coming years, I certianly don't have a precise, to-the-cent forecast of next year's earnings.
But for the companies I recommend for Motley Fool Dividend Investor, I know that they are solid businesses, with impressive earnings and dividend histories. Importantly, they are businesses that I expect will continue to grow their earnings and dividends at attractive rates in the years ahead, and whose prices represent good value relative to those expectations.
(By the way, we already have 11 great dividend dynamos on our scorecard — which has so far significantly outperformed the market and is offering income hungry investors a yield of 4.6%, mostly fully franked. And there are more great recommendations to come…)
Ignore the mangy mutt of short term share prices, and focus on who is holding the leash!
