Wry & Dry

Want to leap February?

2016 is a Leap Year, also known as a bissextile year.  Which in itself is an interesting concept.  Apparently someone decided to add an extra day onto the lonely month of February, giving it 29 days [1], so as to keep the calendar year synchronised with the astronomical year.

Well, Wry & Dry wants someone to decide to Leap February.  Just cut it out altogether.  Just look at how the month has started on the share-market;

So son... 3

And on Wednesday, the Australian share-market fell almost to the point where its return (including dividends) from October 2007 - the peak before the GFC - fell to almost zero per cent.  

Yes, had you invested $100 on 31-Oct-2007 in shares making up the All Ordinaries Index your investment would, yesterday morning, have been worth just $103.79.   That's a $3.79 profit over 8.25 years.  Or 0.45% per annum.  

An economist might round that down to zero per cent per annum.  Good grief.

Share market since GFC 2

But it's actually worse than that. In a purely capital sense (i.e. before dividends), that's a 26% fall in price over the 8.25 years.   Which is -5% p.a.  (Which sort of makes sense i.e. an approximate 5% dividend return lifts the total return to 0%.)      

What went wrong?  Where is that 11.5% to 12% annual return everybody talks about.  Well...

1.  It was unwise to invest at the very peak of the market (W&D perfect hindsight comment); and

2.  Australian company profits (or earnings) per share have fallen by about 25% since then, so an investor would expect share prices to change by about the same amount.  Investing 101: over time, share prices should vary by the change in earnings per share.

Whaaaaat, W&D hears some readers cry, how can company profits have fallen by 25%?  What about the massive bank profits?  

Well, firstly, notwithstanding seemingly massive profits (but averaging only an 8% p.a. increase since the GFC) the banks have issued massive amounts of shares.  And hence profits per share have increased by only about 2.1% p.a.  Not a great return.  The compounded problem for the banks is that they paid out very large dividends and so had to issue more capital to pay for the dividends.  A somewhat short-sighted policy.  But, as W&D has oft pointed out, it amply rewarded board members and senior executives whose bonuses depended largely upon 'total shareholder return' i.e. share price increase in any one year, plus dividends.  Those guys have had their cash payouts.  But the shareholders have had a lousy deal, obscured by high dividends.

Secondly, about 8% of the share-market that existed in 2007 doesn't exist today.  These are companies that went bust.  And so the (somewhat leveraged) profits of 8% of the market also doesn't exist today. 

Thirdly, property trusts also issued massive amounts of capital, as they were very highly leveraged.  Hence their earnings per share has also actually fallen.        

So what!

The so what is twofold:

One: don't invest in an over-valued market.  Or an over-valued portfolio.  According to J.P. Morgan Asset Management, on 31-Oct-07, the share-market P/E was 17.  So, it was perhaps unwise to invest then.

On 31-Dec-15, it was almost 16.  The long-term average is about 15.  There is much merit in having a portfolio that has a P/E considerably cheaper than its long-term average.

Two: invest in companies or a portfolio with expected long-term profit growth per share.  Don't be fooled by a company that has to keep raising capital (i.e. issuing shares) to grow (rather than paying lower dividends and using the retained profits to grow). 

And remember that down (or bear) markets happen.  Sometimes painfully.  But that is part of the life of a long-term investor.