Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 498

Why stock prices are a distraction

Stock market prices are like email: they’re distraction machines. With email, it often distracts people from getting work done efficiently. With stock prices, they distract investors from what really matters: the businesses underlying them.

Ralph Wanger, a legendary US small cap fund manager, knew this well. Wanger ran the Acorn Fund from 1970 to 2003, clocking 16.3% annual returns compared to the S&P 500’s 12.1%. He used the following analogy to describe the behaviour of a typical investor:

“There’s an excitable dog on a very long leash in New York City, darting randomly in every direction. The dog’s owner is walking from Columbus Circle, through Central Park, to the Metropolitan Museum.

"At any one moment, there is no predicting which way the pooch will lurch. But in the long run, you know he’s heading northeast at an average speed of three miles per hour.

"What is astonishing is that almost all of the dog watchers, big and small, seem to have their eye on the dog, and not the owner.”

Wanger’s point is that investors are transfixed by stock prices (the dog), when they should focus on businesses (the dog owner).

Put another way, the performance of a business will be ultimately reflected in its stock price.

100 baggers

What parts of a business’ performance should be tracked?

Thomas Phelps, a US-based financial analyst and advisor, had some answers. Phelps wrote a well-known book called ‘100 to 1 in the Stock Market’ in 1972. It was about his quest to find stocks that could increase by 100x.

In the book, Phelps created a table of basic financials for Pfizer over a 20-year period.

Simple stuff.

Phelps then went on to ask: “Would a businessman seeing only those figures have been jumping in and out of the stock?” His conclusion: “I doubt it.”

True enough. The table shows Pfizer sales went up 6.7x over 20 years, earnings increased 4.7x, dividends climbed 3.5x and return on shareholder funds was consistently high, averaging close to 17%.

If you’d focused on Pfizer’s price, you may not have hung on to the stock. The stock had highs and lows, and significantly underperformed the market over a five-year stretch during that period.

And because so many people have been “sold on the nonsensical idea of measuring performance quarter by quarter - or even year by year - many would hit the ceiling if an investment advisor failed to get rid of a stock that acted badly for more than a year or two.”

Bailing on Pfizer would have been costly. The stock went up 25x excluding dividends over the 20 years.

Phelps issued a challenge to his readers:

“The secret of success in your quest for 100-to-one stocks is to focus on earnings power rather than prices. Can you do it?”

Similar strategies

Several current fund managers use similar metrics to Phelps to track business performance.

Warren Buffett’s business partner, Charlie Munger, zeros in on a business’ return on capital to determine whether it can deliver satisfactory returns:

"Over the long term, it's hard for a stock to earn a much better return than the business which underlies it earns. If the business earns 6% on capital over 40 years and you hold it for that 40 years, you're not going to make much different than a 6% return—even if you originally buy it at a huge discount. Conversely, if a business earns 18% on capital over 20 or 30 years, even if you pay an expensive looking price, you'll end up with a fine result."

Francois Rochon, a Canadian-based global fund manager, uses a comparable table to Phelps to explain his investment philosophy.

The first thing to note is that Rochon has crushed the market over the long period. He’s done it by focusing on companies that can deliver +15% EPS growth over the long term. In the table, he measures the value of his portfolio by calculating the EPS growth plus dividend yield of his fund holdings each year. The 13.3% annualized return is close to his target of 15%.

Compare that to the S&P 500, which has delivered 8.2% annualized growth in value, as measured by annual EPS growth plus dividend yield.

Rochon’s theory is that the EPS growth plus dividend yield will eventually be reflected in stock prices. And the table demonstrates that he is largely correct.

Terry Smith, a UK-based manager of the highly successful Fundsmith, provides a more sophisticated table of his global fund’s key metrics:

From the table, you can see that Smith is a growth investor who likes businesses with high returns on capital employed (it’s like ROE but includes debt in the calculation), high margins, ones that converts profits into cashflow (a check on whether there’s any funny accounting involved) and have high interest cover (ensuring earnings before interest and tax can comfortably cover interest expenses).

If you compare Smith’s metrics to the S&P 500, you’ll notice that the businesses in his fund have much higher ROCEs, margins, and interest cover, with identical cash conversion rates.

Smith thinks that if he owns businesses with superior fundamentals as outlined in this table, and he buys them at a multiple similar to the market, then he should deliver market-beating returns. And he’s been proven right with his long-term track record.

The Morningstar point of view

Morningstar analysts focus on identifying moats or sustainable competitive advantages. While the assessment may be qualitative in nature the financial statements will reflect the impact of the sustainable competitive advantage. A company with a moat will have a return on invested capital (“ROIC”) that exceeds the weighted average cost of capital (“WACC”). In layman’s terms this means the company will be able to generate a return by investing in the business that exceeds the cost it takes to raise capital. If a company can raise capital at 7% and earn a 10% return the difference will accrue to investors over time.

Buffett’s take

Like so many things in investing, the final word on the topic should go to Warren Buffett:

“Games are won by players who focus on the playing field – not by those whose eyes are glued to the scoreboard. If you can enjoy Saturdays and Sundays without looking at stock prices, give it a try on weekdays.”

 

James Gruber is an Assistant Editor at Firstlinks and Morningstar.

 

  •   1 March 2023
  • 1
  •      
  •   
1 Comments
Julie
March 02, 2023

Love the Wanger analogy. Ignore the noise!

 

Leave a Comment:

RELATED ARTICLES

Is ResMed a trap or an opportunity?

Market narratives are seductive and dangerous

Beware the headlines as averages don’t tell the whole story

banner

Most viewed in recent weeks

Retirement income expectations hit new highs

Younger Australians think they’ll need $100k a year in retirement - nearly double what current retirees spend. Expectations are rising fast, but are they realistic or just another case of lifestyle inflation?

Four best-ever charts for every adviser and investor

In any year since 1875, if you'd invested in the ASX, turned away and come back eight years later, your average return would be 120% with no negative periods. It's just one of the must-have stats that all investors should know.

Why super returns may be heading lower

Five mega trends point to risks of a more inflation prone and lower growth environment. This, along with rich market valuations, should constrain medium term superannuation returns to around 5% per annum.

The hidden property empire of Australia’s politicians

With rising home prices and falling affordability, political leaders preach reform. But asset disclosures show many are heavily invested in property - raising doubts about whose interests housing policy really protects.

Preparing for aged care

Whether for yourself or a family member, it’s never too early to start thinking about aged care. This looks at the best ways to plan ahead, as well as the changes coming to aged care from November 1 this year.

Our experts on Jim Chalmers' super tax backdown

Labor has caved to pressure on key parts of the Division 296 tax, though also added some important nuances. Here are six experts’ views on the changes and what they mean for you.        

Latest Updates

A speech from the Prime Minister on fixing housing

“Fellow Australians, I want to address our most pressing national issue: housing. For too long, governments have tiptoed around problems from escalating prices, but for the sake of our younger generations, that stops today.”        

Taxation

Family trusts: Are they still worth it?

Family trusts remain a core structure for wealth management, but rising ATO scrutiny and complex compliance raise questions about their ongoing value. Are the benefits still worth the administrative burden?

Exchange traded products

Multiple ways to win

Both active and passive investing can work, but active investment doesn’t in the way it is practised by many fund managers and passive investing doesn’t work in the way most end investors practise it. Here’s a better way.

Economy

The Future Fund may become a 'bad bank' for problem home loans

The Future Fund says it will not be paying defined benefit pensions until at least 2033 - raising as many questions as answers. This points to an increasingly uncertain future for Australia's sovereign wealth fund.

Investment strategies

Managed accounts and the future of portfolio construction

With $233 billion under management, managed accounts are evolving into diversified, transparent, and liquid investment frameworks. The rise of ETFs and private markets marks a shift in portfolio design and discipline. 

Property

Commercial property prospects are looking up

Commercial property is seeing the same supply issues as the residential market. Given the chronic undersupply and a recent pickup in demand, it bodes well for an upturn in commercial real estate prices.

Infrastructure

Private toll roads need a shake-up

Privatised toll roads in Australia help governments avoid upfront costs but often push financial risks onto taxpayers while creating monopolies and unfair toll burdens for commuters and businesses.

Sponsors

Alliances

© 2025 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.