By John Del Vecchio
Of all Aesop’s Fables, the race between a slow tortoise and a fast hare might be the most classic.
The hare was so sure he’d win that he took a nap part way through the race. Meanwhile, the tortoise just plodded along.
In the end, the tortoise wins the race. It’s as simple as it is effective, with limitless applications.
The stock market is a pretty good one.
Over time, quality outpaces hype. Specifically, earnings quality. Companies reporting truly sustainable earnings outperform glossy growth stories over longer time frames.
It’s a marathon, not a sprint.
With the stock market at all-time highs, valuations stretched to the maximum, and an overly optimistic investing public, you might think that the hype-fueled stories are winning out.
After all, these are the types of stock stories that are easy to get sucked into.
They’re “revolutionary” and creating new markets. It makes for great conversation at summer barbeques – and you can brag about your recent winnings.
However, the exact opposite is happening. Names with quality balance sheets are winning out.
This is even more surprising given that programs like the Federal Reserve’s quantitative easing (QE) encourage excessive risk taking. That means companies might be rewarded by taking on more leverage to try and juice their returns on invested capital.
That quality is winning out – and by a wide margin right now – suggests some sanity in this record-breaking bull market.
This fact, combined with a recent decline in stock buybacks, means the market is setting itself up for one more big run.
Buybacks have been a key driver of stock performance since the lows in 2009. Recently, they’ve slipped, but patterns suggest they may start to tick back up.
If the blue line above were to follow the normal pattern, we should see an increase in buybacks over the next several weeks. Companies in the best position to buy back their stock have strong balance sheets.
The market is anticipating another boost from stock buybacks.
But not all buybacks are equal.
At Hidden Profits, we love getting paid first by the companies in which we’re invested.
Buybacks are one way to do that, but some companies use these repurchases to reduce share count and boost their earnings per share in low-quality ways. Management may finance the buybacks with debt while the business itself is underperforming.
Make no mistake: This is a way to take the shareholders’ eye off the ball.
Thankfully, investors are catching on by rewarding higher-quality companies.
This is our focus at Hidden Profits. My Forensic Accounting Stock Tracker (FAST) system adjusts for the shenanigans management may play with buybacks.
This fall, at the Irrational Economic Summit, I’ll highlight one of those hidden opportunities that has the ability to return billions of dollars to shareholders. It’s an interesting story about an equally disruptive company. I hope you can join me in Austin, TX, from October 25-27!
Good luck out there,
Originally published in The Rich Investor.