While rising equity markets are good for obvious reasons, it’s generally bittersweet for value investors. Those who insist on never paying more for a stock than what they perceive to be its intrinsic value are constantly on the lookout for good deals. In times like these in which markets rise and break through new highs, a certain sense of reservation sets in.
While it’s critical to always understand what a stock is reasonably worth before buying shares, it’s also important to not go overboard. Warren Buffett famously said that it’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price. The logic here is evident: over long periods of time, a difference of a few dollars in share price is trivial. In that same vein, if you’re unsure whether the market’s run still has legs, or conversely, if we’re on the precipice of a correction, here’s another bit of Buffett wisdom to put things in perspective.
Don’t try to time the market
Warren Buffett has stated publicly that his favorite holding period is forever, and also that with regard to Berkshire’s investment strategy, “inactivity strikes us as intelligent behavior.” It’s true that the market is now in somewhat uncharted territory. We recently broke new all-time highs on both the Down Jones Industrial Average and the S&P 500 Index. Valuations have increased, and the price-to-earnings ratios on many of America’s blue-chip companies are higher than they have been in recent memory. You might be understandably interested in taking profits while you can, but it’s important to separate the wheat from the chaff. Many of the market’s highest-quality stocks still trade for entirely reasonable valuations.
If you were fortunate enough to buy Exxon Mobil Corporation (NYSE:XOM) exactly one year ago, you’d be up 10%, including reinvested dividends. That’s a solid return, and with the market sitting at new highs, you might be tempted to sell. But consider that one of the best aspects to owning Exxon Mobil Corporation (NYSE:XOM) over long periods of time has little to do with its stock price. If you sell, you’ll lose the dividends that have accounted for so much of the stock’s total return over the last several decades.
Last year Exxon Mobil Corporation (NYSE:XOM) raised its dividend 21%, marking the 30th consecutive year of a dividend increase. Over the past ten years, we’ve experienced volatile oil prices and the worst recession since the Great Depression. However, over those same ten years, if you’d simply held Exxon Mobil Corporation (NYSE:XOM), you’d have more than tripled your money.
Consider toy giant Mattel, Inc. (NASDAQ:MAT). Had you purchased the stock one year ago, you’d be sitting on a 33% total return. During that time the stock’s price-to-earnings ratio has climbed from 15 to its current level of roughly 18 times. The company’s trailing P/E is now slightly above the P/E on the S&P 500, and you might be tempted to sell.
However, if you do that you’ll have to find a way to replace the 3.3% income you’re getting as an owner, in addition to the rising stream of profits the company has provided its investors for so long. Mattel has almost doubled its dividend over the past five years.
Alternatively, consider railroad Norfolk Southern Corp. (NYSE:NSC). Had you bought shares one year ago, you’d be sitting on a nice 17% gain including reinvested dividends. The stock now trades for a trailing P/E near 17. You could decide to take profits out of fear that a correction might take hold, but it’s worth remembering that the company itself continues to execute admirably.
Norfolk Southern’s revenue is up 38% since 2009. In addition, the company increased its dividend more than 18% last year, and still carries a very comfortable 30% payout ratio. There’s more than enough room for Norfolk Southern to keep growing its profits, and in turn its dividend, at high rates going forward.
Put it all together, and the truth is that…
Timing doesn’t matter. While it’s certainly reasonable to sell a portion of your stock holdings if share prices suddenly soar and the underlying fundamentals aren’t keeping up, it’s almost never advisable to pull all your money out at once. There are a variety of good reasons to sell stocks, but it seems that ‘slight overvaluation’ is not one of them. Just because a stock’s P/E ratio has gone from, say, 15 to 18 times, doesn’t mean that it’s an automatic sell.
Unfortunately, nobody can predict the future, despite the best efforts of legions of investors who try to do just that every day. These stocks pump out reliable dividends every year, regardless of the swings in their share prices. Even better, they have demonstrated the ability to raise their dividends on an annual basis. Rather than worrying about the direction of the next few points of share price movement, sit back, reinvest those quarterly checks, and let Warren Buffett’s advice be your guide to a comfortable financial future.
The article Wisdom From Warren Buffett That is Especially Relevant Today originally appeared on Fool.com and is written by Robert Ciura.
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