You Can’t Pin Down Mr. Market

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You, the investor, must choose between investing in two companies based on their financial results over two years. One has steady revenue and earnings growth, alongside decent dividend growth. The other experiences moderate financial decline, but boasts strong dividend growth. Given this information beforehand, which would be the better investment?

In our final episode of the year, Greg revives the classic game show Let's Make a Deal to illustrate that even if you know the future, some aspects of investing will always be unknowable. Later, Greg continues this theme by discussing broader market valuation, and predictions from various analysts for 2025 and beyond. To tie everything together, Greg concludes the episode by reflecting on a TED Talk that emphasizes the importance of a long-term strategy and the pitfalls of short-term thinking.

Happy Holidays from The Dividend Mailbox Team

00:00 Introduction to The Dividend Mailbox
00:46 Let's Make a Deal: Investment Choices
02:47 Behind Door Number One: A Declining Company
04:54 Behind Door Number Two: A Growing Company
05:45 Comparing the Two Companies
08:05 Revealing the Companies and Market Insights
12:34 When to Sell: Strategies and Considerations
19:16 Market Predictions and Analyst Opinions
27:43 Long-Term vs Short-Term Investing
33:38 Conclusion and Final Thoughts

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Resources:

📅 Schedule a meeting: Financial Planning & Portfolio Management
📊 Getting into the weeds: DCM Investment Reports & Models 

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Disclaimer: Past performance does not guarantee future results. Every investor should consider whether an investment strategy is right for them and all the risks involved. Stocks, including dividend stocks, are volatile and can lose money. Denewiler Capital Management may or may not have positions in the publicly traded companies mentioned herein.

Transcript

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[00:00:11] Greg Denewiler: 

This is Greg Denewiler and you are listening to another episode of The Dividend Mailbox, a monthly podcast about dividend growth. Our goal is to stuff your mailbox full of dividend checks. When they grow over time, a funny thing happens, you create wealth.

Welcome to episode 42 of The Dividend Mailbox. Today we're going to change things up a little bit, because it's not the dividend mailbox, it's let's make a deal. I think it'll be a great illustration as far as how challenging investing can be, and even if you know the future, you may not know what's behind door number one. So after that, we're going to look at the overall marketplace—some of the things that have been out there recently, as far as market valuation, and I'll give you a couple of points that help me keep things in perspective as the year comes to a close and we start to go into next year.

So today we have a treat. I don't even know if it's still on, but years ago when the dinosaurs were still around, there was a show called Let's Make a Deal, and they had three doors. The contestants dressed up and they had to pick one and they would kind of give you a teaser. Everybody sat there and waited for the big pick, the big reveal of what was behind door number one, two or three.

Well, our show's a little different. We only have two doors. This is all going to make sense when we get to the end, but imagine it's May of 2022, and you're thinking about what to do with your money. Now, behind each door is an investment choice, and you're going to get the results of the company, and how they actually performed over the next two years through October of 2024. Then you're going to choose between company number one or company number two. 

So let's make a deal.

Behind door number one is a company that actually has revenue from the quarter ending in April 30th of 2022 out to the quarter that ends in October of 2024, it actually has revenue that declines by almost 11%. Net income declines by 5%. The margin story is a little bit better—margins go from not quite 44% to almost 47%. They improved by about 3%, and you had the margins for net income go from 13.4% to 13.8%. The underlying business is getting a little bit better, but the business is not growing from a revenue or net income standpoint, it's actually declined a little bit. This is actually confirmed with cash from operations, it declines fractionally from 1.4 billion to 1.3 billion. So for all intents and purposes, the company in this case, I'm not even sure you can call it stable, it actually declines. But the reason why I hesitate is because when you look at earnings per share, they actually increased by 10% over that slightly more than two year period. The yield for company number one begins in May of 2022 at 2.8%, and the dividend actually grows by 46%. The dividend growth has definitely been good. So the underlying business, what's happening, the shares have declined. They've gone from 140 million to 123 million. And they bought back stock. That's helped improve the profitability of the underlying business from an earnings per share and a dividends standpoint.

So now, we're going to go to door number two. And on door number two, we have revenue growing by 12%. Actually, earnings per share growing by 17%. The net margins improved better than company number one, but they started a lower rate. They go from not quite 11% to almost 13%. So this company actually, the underlying business is actually getting a little better, faster. But when you look at the dividend, the yield for company number two begins at around 1.5% and the dividend has grown by 17%. That is still a pretty good number, but not as good as company number one. So now you're faced with a decision. And again, to review, door number one, the actual revenue and then income is not growing. It is declining, but the dividend has grown a lot faster than company number two. For company number two, it basically was just pure organic income and revenue growth, and you have decent dividend growth, but not as fast as company number one. So now I'm going to pause for a little bit of time here to think about it and pick one.

Well, most people in today's market are probably going to choose company number two, because we're in a very growth oriented market. Growth comes with a premium and people are willing to pay up for it. Just the perception of growth can earn a very attractive return. Either one, earnings are going to go up and somebody is willing to buy the company later, or the company has the ability to pay dividends down the road. Even if the PE doesn't expand and earnings go up, it just means that investors are entitled to more money. So I would say the average person is probably going to pick door number two. But now how did the price perform between one and two? 

You're already probably picking up a hint here, but I can virtually guarantee you that you're not even going to come close to the performance of how these two reacted over the exact same timeframe. Company number two—we're going to start there just for a little suspense. There, the price of the stock changed 52%. So over two and a half years, you're thinking: “That's pretty good. I'll take 52% and I'm getting a dividend and the dividends growing. Man, I don't want to take the risk of what's behind door number one.” Here's the thing, door number two is the S& P 500. It's just the market. For company number one, the stock has appreciated over the same time period by 247%. I mean, we're talking major out performance and the first thing that should come to your mind is how in the world did that happen? There really wasn't much growth there or at all. You just would not have expected the company to perform the way it did. Well, there's a couple of things at play here and you can't see all this, I'm not giving you all the details, but I think the first takeaway should be it is extremely hard to forecast the future. Because you can even see all the numbers and make an educated guess of how the average person should react, and guess what? The average investor may react completely different in two scenarios that are not that much different if you just take them face value. 

Well, what I intentionally omitted was that company number one starts out at a P/E of seven. That's very cheap, and it's well below the market at that time period. And you're wondering, well, why was it so cheap? Well, it's retail— we're slowly getting to the name here. So if you remember back to 2022, there was a lot of talk of a recession and the S&P 500 actually finished the year down 18%. If there's a looming recession out there or investors are very nervous that one is imminent, then they're just not going to pay up for a retail company, because retail is very cyclical, they were convinced that earnings were going to decline and sometimes they can decline significantly. Well, what ended up happening? No recession, margins for this business improved, even though it didn't grow, it showed stability, it showed the underlying business actually improving a little bit. The PE went from 7 to currently it's 23. And when you have PE expansion like that and everything else is roughly equal, then you have huge price performance, that's exactly what happened. 

Well, time to find out what's behind door number one, and the answer is it's Williams Sonoma. You might've guessed if you've listened to us in the past but regardless, given all the stats that you've heard, and even as we look at the company now realizing how well it's performed, there is somewhat of a question of why it did so well so fast. Investors were really willing to bid this thing up. It surpassed our expectations. I mean, if we had known this was going to happen, we definitely wouldn't have started with a third position, but sometimes you get lucky and what you think will take 10 years takes two years and other times it takes longer. But the point is you build a portfolio. Some of them work really well. Some of them not so much. Being a contrarian can be extremely profitable, sometimes that's the only way you can get a really decent price on a great business. Of course, the key is, to try to make sure it's a great business, and then if the price is favorable, it's all about having the confidence of having a long-term picture and a long-term objective— having the confidence that what you do is going to pay off in the long run.

Well, this is really about education, that's what this podcast is designed to do. It is not to give you specific recommendations of when to do what in what timeframe or when. So here's the problem now, and here's where this is going. We get questions about when do you sell or at what point—how do you determine when to sell a big winner?

First thing I'm going to tell you, we did sell 25% of it several weeks ago because the stock's getting very expensive. The dividend yield now is down to a little over about 1.1%. So we don't have any dividend yield here. If you remember in our story, when we originally pitched this, the model that we created for this thing had them buying back a lot of stock, and at a very low multiple because of the cashflow and it was so cheap, we could potentially get a 200 plus return on this thing without really hardly any growth at all, just managing the cashflow.

Well, they've managed the cash flow and the market has responded. But now in our case, if we were looking at this as a new idea this thing would get off the screen in about three minutes. Because number one, the dividend is very low and they're going to continue to raise it relatively aggressively, but to get back to our sweet spot of 2.5-3% yield, we have to get 11% growth on an annual basis for 10 years—which we think will happen—but that's just to get us back to where we like to start. Our normal situation is we try to target around 2. %, 7.2% growth a year doubles it, gets it to 5% in 10 years. If we're starting out buying this company today and it has a yield of 1%, then to get it up to 5%, we have to have this dividend grow by 17% a year for 10 years. Well, that's a pretty aggressive number and a lot can go wrong over that period of time. So the moral of the story is, we reserve the right to sell all or part of this at any time going forward. The reality is we are probably going to sell more of it because we're just going to look for other ideas. Just looking at money market, which is where this money did go and will go at the moment while we continue to look for a strong new idea, we can go up to over a 4% yield. That means we're almost a 300% gain on the income just by letting it sit in money market. So we give up nothing on a yield basis, and again, we've got a dual mandate. We're all about total return and we're all about dividend income and combining them both together to form a coherent strategy of long-term wealth building. If you look going forward, in order to get any real total return growth out of William Sonoma, if anything we could easily see the PE contract a little bit from here. If we go back to our 10-year model and we start where the stock is today, we grow the 1% dividend up to a 3% dividend yield based on its current price, then that means that if the stock trades at 3% in 2034, it's only selling for $180 a share. Right now the stock is already above that, so it's pretty hard to build a case of why stay in this. Yeah, we may get the dividend growth, but the total return is just not there. 

From that standpoint, William Sonoma worked. We get to check the income growth box, it grew by more than our hurdle rate of 10%. We get to check the total return box because our threshold really is to double our money in 10 years—our minimum threshold at 7. 2%. We greatly exceeded that number. It would have been nice to have watched that dividend grow and to get the income growth, but the reality is when you get a chance to get your most optimistic expectation we had in a matter of two and a half years, instead of having to wait 10, you take it. So that's where we are on Williams Sonoma. 

And another great piece about this illustration is that most people think that dividend growth is A, Boring and B, Just won't give the numbers that people want. Well, William Sonoma has been evidence that they're not all boring and that it has a growth component to it, which is what we keep hammering over and over again. They don't all work out like this. This is a case where we got the exception to the rul. We take it because that's just what happens when you have a diversified portfolio, usually over time. We have a few that are not performing quite as well, but when you get some things like this, it really does help out the total portfolio return over time.

But, you know, one of the problems in today's environment, you probably have not read about William Sonoma in the media or anywhere. It's a story that's kind of underlying, that's under the radar, which most of these are because they don't have the excitement of NVIDIA, or I could go on and on about some of the big tech names. Where we're going to transition into next is some of the comments that have been in the Wall Street Journal lately. Its becoming somewhat common for analysts or economists or the media to write about with everything underlying that's going on, we could be in for a very difficult decade of generating returns.

And as we approach the end of the year, all of the predictions start to come out for 2025 and beyond. The Wall Street Journal has been active recently. In the December 7th issue, Saturday, there was a column by James McIntosh. And the article was “Equities are wildly overvalued right now.” He proceeds to go through and bring up some of the points, why he thinks we may be in for some real problems from a standpoint of performance for 2025. He lists Goldman Sachs, they predict that the market is probably only going to average at best 3% a year for the next 10 years. Bank America slash Merrill Lynch predicts even a little worse return. They're looking for an average of between 0 and 1% a year for the next decade. It's really just based on the fact that we're at valuation levels that are extended fairly dramatically. But also currently Ed Yardeni thinks that the S& P 500 could hit 7,000 by the end of 2025. And Thomas Lee thinks we could hit 7,000 by the middle of next year, even quicker. These are actually two names that I have respect for, even though pretty much nobody can predict the future.

One of the things that has to come up, is everybody's looking at the same numbers, but you're getting some wildly different interpretations, not to beat a dead horse, but nobody can predict the future. You can only take some educated guesses of the future and some people are more educated than others. When you look at just how the S& P 500 is broken down, the top 10 have a PE of 30, and the last 100 stocks of the S& P 500 have a PE of 15. So there is a gap in their valuation, which is actually potentially a good sign for the future because some of the market is extremely expensive and some of it is not. What could happen is these big expensive tech names could stall out for a while. And this is a similar situation that happened in 2000 when tech peaked, the broader market and the quote value sector really started to do well. So quite possibly, there could be a repeat of that scenario. 

Another thing that plays into this, I think is the S& P 500 has changed. When you're looking at these predictions, you have to look at what's behind them and a lot of times there's some version of a reversion to the mean. Well, when you've got these big tech names that represent a significant part of the S&P 500, and if you're going to use earnings, which come from profit margins and profit margins in tech are much wider, well, there's never going to be a reversion to the mean of where manufacturing was a few decades ago. So, things have changed, but you do have to look at, okay, it's different, but you probably shouldn't value those higher margins at 30 or 40 times earnings indefinitely.

Another piece that's come up is a BlackRock, one of the largest institutional managers out there, is investing heavily in the private markets. McIntosh views that as a sign that they're not as excited about the public market. Well, that's just one way that BlackRock tries to be a source of investment returns for their investors. The only problem is the average investor tends to not have the opportunity to buy what is really attractive there. Those tend to go to more institutional type buyers. You know, we get calls, wholesalers trying to sell us different ideas. I have to tell you, having been in the business for as long as I have been, if somebody is calling an advisor who has roughly a hundred million dollars offering access to a private equity deal, I don't even look at it because I have to be realistic. If they're trying to show me something, then that means the really big institutional money isn't looking at it. That pretty much means why in the world would I want to look at it? So even if BlackRock is correct, that's good for the institutional side, but for the individual investor its probably not going to be that much more attractive than just the public markets. So that's all I'm going to say on that. 

Just to pursue this a little further, in the December 17th Wall Street Journal, Mr. McIntosh, who really seems to be on this topic, writes another article in the wall street journal And he says: “Why this frothy market has me scared.” He goes through these points of bulls are everywhere. Consumers are expecting stocks to have a good strong 12 months. Consumer sentiment is the highest it's been since 1988. Well, I agree. That's a little bit of a yellow flag. Another point, the other signs of optimism are newsletter writers are very bullish. And I agree with this to a degree on some of these stocks currently, no one cares about valuation. It seems to be all about momentum and the story. 

Another point he makes is insider trades—you have net sellers. Large executive insider selling is valid. It is an indicator, but when you have a market that has moved, where you've had the S&P 500 put back-to-back years of substantial gains, It's only natural that they potentially are going to sell part of their holdings to diversify their portfolios. I'm not sure how much weight to put into that indicator. 

So McIntosh brings up some good points, but the problem is the exact timing of when we may get a correction is basically unknowable. One of the old sayings in Wall Street is: If you're too early, you're wrong. And even Macintosh admits that next year could be relatively good.

I mean, here's something that is fascinating. The lead article on the Barron's December 14th issue was why the stock market could gain another 20% in 2025. Without going through the details on that, it's all the reasons, AI is part of it, better productivity. The potential new administration coming in, less regulation, things are a little bit more pro business, you know, same old stuff. But here's the fascinating thing, Barron's and the Wall Street Journal are owned by the same company. Red flag alert here. They're just trying to get you to read whatever they're putting out because that's how they sell advertising. So you kind of have to be careful. Nobody knows the timing, and in the end, it's really about deciding whether you're trying to play a long game or you're trying to figure out what happens in the next month. The next month is extremely difficult to predict.

This leads to a TED talk that has actually been out there for a long time. It was originally issued in October of 2016. It was by—hopefully, I pronounced this guy's name, right—Ari Wallach. The name of the TED talk was: “Three ways to plan for the very long term.”  What you have to decide—and this is why we went through the Williams Sonoma situation earlier in the podcast—you have to decide what game you're playing. This is where it really gets important because Ari goes into a few examples. One of them is he calls it the sandbag principle. This is kind of easy to relate to. He uses one example where the storm is coming and you put sandbags around your house. The waters rise, but the sandbags hold back the water and it works. And the next storm comes and you put sandbags out again, but the real problem is you need to fix the dike. Well, the dike takes a lot of time and you have to pay more for that solution. 

He used another example where he goes out to dinner and he's got some young kids, they're noisy, there's a lot of activity going on at the dinner table and he just wants to sit there and relax. So what's he do? He gets out the iPad or the iPhone, turns the movie on or lets them play a game and that takes care of the problem. It’s a short-term solution. Well, the long-term solution to fix the problem, that's really not teaching them how they should conduct themselves out in public in a social environment.

The funny thing about life is the lessons are really relatively universal. If you want to be in shape, you've have to go work out. You have to get up in the morning or you got to run after you get home from work or whatever your situation is. You really have to adopt a lifestyle. Short term diets and some of these new drugs out there, they work until you stop taking them. If you don't change your lifestyle, so you don't have a vision of a long term picture, you're just going to gain weight again. You have to go through some pain and it takes a while for it to work. 

Investing is no different. Short term earnings management, quarter to quarter companies cut back on maybe R&D or safety, or don't invest as much, and that comes at the long term health of the company. We've gone through this in multiple of these podcasts, companies that try to do things, they buy back stock at very high prices, or they make acquisitions. They put them out as long term solutions, but they're really trying to ramp up sales and earnings short term. When you're looking at growing cashflow, some of what a company should do to grow cashflow is going to potentially go against short-term earnings. And I will give Williams Sonoma credit for this, they've shown some discipline there. The real point of the Ted talk was short-termism, it just really permeates through society now, and it continues to get worse. And it's for the obvious reasons that social media is constantly in our face and the wall street journal and Barron's and everybody else on the planet is trying to get you to pay attention to what to do in the next seven days. Well, guess what? Short-termism and long-termism do not go together. So you have to figure out which model you're playing. There is a difference between the two.

We're back to another market this year where the S&P 500 as of two weeks before the end of the year, it's up, I believe about 27%. The Dow is only at 15%.

You've got these different indexes that have dramatically different performance. Our model portfolio, which again, I want to stress, we only have one client that has this exact portfolio. All the other clients have different pieces of it. As I've said in the past, this is just kind of a guidepost that we use to see whether we're on the right track of our overall philosophy and strategy. This year, the dividend income is going to be up 8.4%. The S& P 500 dividend as of the middle of December, which, we're going to get some numbers at the end of the year, so it could end up being a little bit more, but right now it's up about 4.5%. So our income growth is double. In fact, longer term on an annual basis we're actually beating it by more than 2%. I can tell you that if our benchmark was the Dow, we're right in there on a total return basis. Because we're up about 15, 16%. Obviously, that means that as of this year we're lagging the S&P 500. Well, simple explanation, in our model portfolio, we don't have any of these big tech names and our other accounts we do own some. But the point is our game is total return long term. And I have a simple philosophy that if that income grows over a decade, two decades, the price growth is going to follow. 

So to kind of conclude, are you going to follow the daily media, trying to figure out where the next trend is and what's going to happen in the next three months, or are you going to spend your time trying to figure out, can this cashflow grow, can it grow for the next decade, is there a reasonably good probability and then what are you willing to pay for it? And yeah, there are people that are phenomenal traders and they have made a lot of money, but those are the exceptions, not the rule. And the great thing about investing and compounding is all you have to do is steer down the middle of the road. If you stay in the middle of the road long enough, the economy, GDP growth and dividend growth is going to get you where you want to go. But the problem is it's not embedded in some article about what's going to happen in 2025. It's embedded about a lifetime of returns. And there's no shortcut to that.

So with that, it's been a good year and we will see what happens as we go into January.

If you enjoyed today's podcast, please leave us a review and subscribe. If you would like more information regarding dividend growth or our investment strategy, please visit us at  Please visit growmydollar.com. There you will find previous episodes and also our monthly newsletter. If you have any questions or anything to add to today's episode, please email ethan@growmydollar.com. Past performance does not guarantee future results. Every investor should consider whether an investment strategy is right for them and all the risk involved. Stocks, including dividend stocks, are volatile and can lose money. Denewiler Capital Management may or may not have positions in the publicly traded companies mentioned herein.