Pain Before Gain

Even when you’ve found the best company to invest in, it’s likely that there will be pain before gain; don’t give up on the company’s stock just because its price has fallen

In my December 2021 article, The Need For Patience, I shared two of my favourite investing stories. The first involved Warren Buffett’s experience with investing in The Washington Post Company in 1973 and the second was about the recommendation of Starbucks shares by the brothers, David and Tom Gardner, during a TV show in the USA in July 1998. 

The thread tying the two stories together was that both companies saw sharp declines in their stock prices while on their way to delivering massive returns. Washington Post’s stock price fell by more than 20% shortly after Buffett invested, and then stayed in the red for three years. But by the end of 2007, Buffett’s investment in Washington Post had produced a return of more than 10,000%. As for Starbucks, its stock price was down by a third a mere six weeks after the Gardners’ recommendation. When The Need For Patience was published, the global coffee retailer’s stock price was 30 times higher from where the Gardners recommended the company.

I recently learnt that Walmart, the US retail giant, had walked a similar path. From 1971 to 1980, Walmart produced breath-taking business growth. The table below shows the near 30x increase in Walmart’s revenue and the 1,600% jump in earnings per share in that period. Unfortunately, this exceptional growth did not help with Walmart’s short-term return. Based on the earliest data I could find, Walmart’s stock price fell by three-quarters from less than US$0.04 in late-August 1972 to around US$0.01 by December 1974 – in comparison, the S&P 500 was down by ‘only’ 40%. 

Source: Walmart annual reports

But by the end of 1979, Walmart’s stock price was above US$0.08, more than double what it was in late-August 1972. Still, the 2x-plus increase in Walmart’s stock price was far below the huge increase in earnings per share the company generated. This is where the passage of time helped – as more years passed, the weighing machine clicked into gear (I’m borrowing from Ben Graham’s brilliant analogy of the stock market being a voting machine in the short run but a weighing machine in the long run). At the end of 1989, Walmart’s stock price was around US$3.70, representing an annualised growth rate in the region of 32% from August 1972; from 1971 to 1989, Walmart’s revenue and earnings per share grew by 41% and 38% per year. Even by the end of 1982, Walmart’s stock price was already US$0.48, up more than 10 times where it was in late-August 1972. 

What’s also interesting was Walmart’s valuation. It turns out that in late-August 1972, when its stock price was less than US$0.04, Walmart’s price-to-earnings (P/E) ratio was between 42 and 68 (I couldn’t find quarterly financial data for Walmart for that time period so I worked only with annual data). This is a high valuation. If you looked at Walmart’s stock price in December 1974, after it had sunk by 75% to a low of around US$0.01 to carry a P/E ratio of between 6 and 7, the easy conclusion is that it was a mistake to invest in Walmart in August 1972 because of its high valuation. But as Walmart’s business continued to grow, its stock price eventually soared to around US$3.70 near the end of 1989. What looked like a horrendous mistake in the short run turned out to be a wonderful decision in the long run because of Walmart’s underlying business growth. 

This look at a particular part of Walmart’s history brings to mind two important lessons for all of us when we’re investing in stocks:

  • Even when you’ve found the best company to invest in, it’s likely that there will be pain before gain; don’t give up on the company’s stock just because its price has fallen
  • Paying a high valuation can still work out really well if the company’s underlying business can indeed grow at a high clip for a long time 

Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life. Of all the companies mentioned, I currently have a vested interest in Starbucks. Holdings are subject to change at any time.