Stock Market Performance Individual Stocks S&P 500 – The Importance of Buying Solid Businesses.

We wanted to share this chart since we think it is a very important point to make in today’s environment. Looking at the below we can see a breakdown of all of the stock (constituents) included in the S&P 500, during the time from 1997-2017, so throughout 20-years.


As we can see the average return per stock is a strong 228% – not bad, but wait! What we can also see is that the median performance, meaning the performance of 50% of the 500-stocks in the index has returned a performance between -100%-50%, so companies that have gone bankrupt, to companies that have produced up to 50% return over the 20 years. Even with a 50% return over the 20-years, that is only around 2% per year. So out of the 500-stocks in the S&P 500 half of those companies has not done anything really to generate returns for investors in the index. Looking at the numbers a bit further we can then see, and assume, that the other half (250-companies) must have done much better since the average performance of the S&P 500 is generally much higher than the above.

This is correct and we can see that the performance of the other stocks has varied between +50% all the up to over 1,000% (that is more than 10 times your money). So why do we want to bring this up? The simple reason is that, while we are not at all against ETFs, a fund that includes all of the stocks in the index will experience the issues that we see below. Half of the companies that the investor is invested in will not perform. Often this has to do with the fact that the companies don’t have the right foundation. They do not make enough money (margins) they do not reinvest the capital they make efficiently, they have problems with competitors because their proposition is not unique or competitive enough, or the business might have taken on too much debt. As you might remember from our Investment Approach section of this page, we look for businesses that have those attributes. So the bottom line is really that as long as you look for businesses that have the right fundamentals in place, you should be investing in businesses that belong in the top 50% of performers in the below chart.

Our job is to find as many of these companies as possible, and buy their stocks.

Shiller PE Ratio

Many of you will be familiar with the Shiller PE ratio or might have heard about it before. The ratio has been established by Robert Shiller, who is an American economist, academic and author. The Shiller PE ratio is calculated by

  • Calculating the annual earnings of the S&P 500 companies for the last 10-years.
  • Adjust the earnings for inflation.
  • Average the adjusted values for 10-years.
  • The Shiller PE is the ratio of the price of the S&P 500-index over the value calculated in point three.
See the chart below.

Source: Quandl, Shiller PE Ratio by Month

As can be seen from the chart, this value fluctuates quite significantly while economies go through boom and bust cycles. Something that is very interesting at the time of writing this during the later spring of 2021 is that the value as we can see is around 37 currently.

This is to be compared with 30 before the “Black Tuesday” which was the start of the Great Depression that hit the US during the 1930s and that lasted for 10-years.

In fact, the only time that the Shiller PE has been higher than it is today was in 1999 during the dot com bubble, and we all know what happened after that.

So what does this mean overall?

It is difficult to exactly know but I would make a few reflections.

  • It is not a bad time to be a bit cautious.
  • The enormous economic stimulus that has been pumped into the system will very likely create inflation at some point in time. Since governments tend to be behind the curve when it comes to implementing economic policy, there is a risk that inflation might take off faster than we expect today.
  • Normally inflation would result in interest rates going up, potentially a lot. This could lead to instability of the real estate markets that have been seen significant, and potentially unrealistic growth due to the current interest rate levels.
  • Finally, should I stop investing because of all of this? Our answer would be a definite no since that would mean that you would be holding loads of cash, cash that would very fast lose purchasing power in an inflationary environment.

So what should we do?

We need to stick to what we know. This means to keep investing in businesses with strong cash flow generation, where we think that the generation of cash is sustainable and growing long term irrespective of shorter-term economic fluctuation, and where we see that the company can protect this cash flow in future. This way we will protect our downside since we can re-invest the cash distributed if the markets go down, as well as enjoy higher asset values in a market that continues to rise.

See our presentation about The Baby Boomless Economy here.