Why Price is King

I’ve featured Jesse Livermore, the pseudonymous blogger at Philosophical Economics, here on TRB quite a bit this year. He’s been smashing it pretty consistently and breaking the backs of the mythmakers at every turn.

I love this bit he just wrote about how price – the unknowable – is always king in the end, despite how far many value investors go to downplay its importance. Methodical investors prefer to focus on the E in PE ratio because the P is nearly impossible to explain, understand or predict, so heavily reliant is it on attitudes, emotions and other non-rigorous squishiness.

But the P is the end-all, be-all when it comes time to feel the money in your fingers.

Here’s Jesse:

The total return of an equity security depends on two factors: (1) the change in price from purchase to sale, and (2) the dividends paid in the interim.  Dividends matter, but price is king.  It drives total return.

Many investors don’t like the fact that price drives total return.  If price drives total return, it follows that total return is a function of the shifting sentiment, preferences and expectations of other people–those who make up the market and “vote” on what the price will be.  Investors don’t want their returns to be subject to the arbitrary “vote” of other people, and so they pretend that as stock market speculators they are actually genuine businessmen who “buy” and “own” companies to hold forever.  They tell themselves that their returns will somehow emerge directly from the cash flows of the underlying businesses, regardless of what the market decides to do with price.

This point of view ignores the fact that it takes decades to recoup an equity investment via dividends, the only cash flows that are ever are actually paid out to buy-and-hold investors.  To claim a return on a stock in any other context, an investor needs someone to sell it to.  The price that other people are wiling to pay is therefore important–supremely important.  Rather than resist this fact puristically, our responsibility as investors is to accept it and work within it, by understanding the behavioral propensities of our fellow market participants, and getting in front of emerging trends in how they choose to allocate their wealth.

That comes from Livermore’s new post about how the supply of equities relative to investors’ average percentage allocation is the most predictive indicator in existence. His working through of the thesis is fascinating to watch, even if you disagree with the conclusion. Head over below to have your fucking mind blown.

Source:

The Single Greatest Predictor of Future Stock Market Returns (Philosophical Economics)