Download PDF→The simple investment concept that businesses that increase profits at a faster rate over time also experience faster price appreciation is supported by longer-term regression analysis.
Presented in the chart to the right (click it for a larger view) is the Earnings per Share NTM (green line) compared to the Weekly Price (blue line) for the S&P 500 index, over the last 10 years. The correlation of these two variables has been .81 (1.00 is a perfect positive relationship). In other words, over the last 10 years, 81% of the growth in Earnings per Share NTM has been translated into the Weekly Price.
When we look at the 10 major sectors of the S&P 500, we see a similar result. Presented below are the 10-year correlation coefficients for Earnings per Share NTM and Weekly Prices. The sectors are an equally weighted group of the current companies in each S&P defined sector. (Emphasis added to enhance readability.)
Likewise, this strong historical relationship is also evident for our portfolio companies. Presented in chart to the right is a portfolio group composite of our equity investments as of 12/31/2013. Over the last 10 years, 86% of the price appreciation has been the result of the growth in Earnings per Share NTM.
Fundamentals & Prices Are Connected
The strong relationship between prices and earnings demonstrated above suggest our in-depth fundamental analysis will translate into price appreciation over time. Prices, on a day-to-day basis, can swing wildly with the latest headlines and investor’s perceptions and emotions. On the other hand, fundamentals (earnings) tend to shift more slowly and underlying trends can be analyzed for quality, sustainability, and consistency. Our goal is to maximize the probability of achieving superior results. The strong connection between fundamentals and prices implies that this can be achieved with high-quality, consistent growth companies.
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