FREE NEWSLETTER

A Seat at the Slots

Richard Quinn  |  October 13, 2020

WHAT DO HIGHER corporate profits truly mean to investors? Or, put another way, this 77-year-old neophyte wants to know, “How is investing in stocks different from gambling?”

Don’t get me wrong, I invest in stocks and I understand they’re the best way for most of us to grow wealthy over time. What I don’t get is, “Why? What causes a stock to increase in value?”

I’ve researched the question and what I find is a lot of talk about earnings per share, price-earnings ratios, earnings growth and such. But rather than answering my question, this stuff about earnings, valuations and so on leaves me even deeper in doubt.

One Sunday evening, I looked at the S&P 500 futures. They were up. But on Monday morning, the market tanked. What happened? Some news that had nothing to do with the value of any individual company, I suspect.

I own shares in my old employer. It’s a utility that’s been around for 110 years and pays a decent dividend. The stock price bounces around from day to day and yet nothing significant at the company changes. For the current quarter, analyst estimates of earnings per share range from $0.31 to $1.04. Should I be concerned? As long as the company pays its quarterly dividend—and continues to pay my pension—should I care about the latest quarterly earnings?

I’m told earnings, or the anticipation of higher earnings, drive share prices. But if I don’t get paid my share of those higher earnings as dividends, why pay more for the stock? Somebody is gambling, I think, but I’m not sure on what—except perhaps on higher price-earnings ratios.

I tend to view the changing value of a stock like art. I’m an artist of sorts, albeit a mediocre one, as you’ll see from the picture below. But if I could get one critic (think analyst) to say a few kind words, someone might buy my art. Then some other sucker, I mean, investor might pay even more, and I’d be on my way.

Picasso and Rothko seem to have done well after a good word or two. How many people understand their art? Why buy a stock for many times its earnings when value seems to be in the eye of the beholder?

On top of that, we have the difference between analysts’ earnings predictions and the actual results. A company meets, beats or doesn’t meet those quarterly estimates and the stock goes up or down. Why do we assume those analyst estimates are valid?

As I read an article about the best dividend-paying stocks for 2020, I scanned analysts’ opinions of each stock. One caught my eye. Four analysts had the stock as a “strong buy,” two as a “buy,” 12 “hold,” two “sell” and three “strong sell.” I guess they use different dice.

Increasing dividends are good. But many companies see their stock price rise, even though they pay no dividend. Investors are paying more for a stock because corporate profits are rising and yet those earnings aren’t getting shared. Yes, I get it, the earnings are being reinvested in the business, supposedly to enhance earnings down the road. But if that cash isn’t coming back to shareholders, why should I pay a higher price for the stock?

About those earnings: It doesn’t seem to matter how they increase. If earnings increase because sales are up and hence profits are up, that’s one thing. But if earnings increase because of workforce reductions or other cost cutting, that doesn’t impress me. Actually, it makes me wonder who was minding the store. How did the company get to the point where staffing and other costs were so out of control?

I read one explanation of rising stock prices that discussed the law of supply and demand. One person wants to sell and another is willing to pay more to buy. But why? Oh, I know, because earnings are expected to grow, so the stock will be worth more in the future. Isn’t that a circular argument?

While trying to figure all this out, I came across this: “[A] stock could… be considered overvalued if prices continue to rise, despite earnings falling short of predicted growth estimates. An overvalued stock is the opposite of an undervalued stock. When a stock is undervalued, it trades at a share price that’s below what the stock is actually worth. ”

Profound, right? So I guess I have to figure out what a stock is “actually worth,” and that seems to have something to do with “predicted growth estimates,” which doesn’t seem to have anything to do with putting cash in my wallet. My head is starting to hurt. How about just sending me a nice dividend check instead?

Richard Quinn blogs at QuinnsCommentary.com. Before retiring in 2010, Dick was a compensation and benefits executive. His previous articles include Want $870,000Taking Credit and Do as I Don’t. Follow Dick on Twitter @QuinnsComments.

Do you enjoy HumbleDollar? Please support our work with a donation. Want to receive daily email alerts about new articles? Click here. How about getting our weekly newsletter? Sign up now.

Free Newsletter

SHARE