In the long term, the stock market tracks corporate earnings

Over the long term, corporate profits will continue to grow, and stocks will follow this progression fairly faithfully. (Photo: 123RF)

GUEST BLOG. A friend recently forwarded me an article that contains an excerpt from the speech given by Peter Lynch, the famed manager, at the National Press Club on October 7, 1994.

Here is that excerpt:

Any event will come out of left field, and the market will go down, or it will go up. There will be volatility. Markets will continue to experience ups and downs… Historically, corporate profits have grown at an annual rate of approximately 8%. Thus, corporate profits double roughly every nine years. So I believe – the market [Dow Jones Industrial Average] being near 3800 today, or 3700 – I’m pretty confident the next 3800 points will be up, not down. The next 500 or 600 points – I don’t know which way they will go. In summary, markets are expected to double over the next eight or nine years. They will double again in the following eight or nine years. Because profits are growing at 8% per year and stocks are following. It’s that simple.»

Was Peter Lynch right? In 1994, as he points out, the Dow Jones Industrial Average was near 3800. Today it’s around 35300. That’s a compound annual return of 8.4%, which is very close to Peter Lynch’s estimate of earnings growth 27½ years ago!

This is, in my opinion, a good proof that simplicity has much better taste. Why do investors always have to complicate their lives so much? Stock market investing is simple: you invest either in quality companies at a reasonable price or in stock market indices, and you sit very wisely on these investments for many years. Anyone who invested $10,000 in October 1994 would now have nearly $82,900. In another ten years, assuming that the growth rate of 8% is maintained, this sum should approach $179,000 and in twenty years, more than $386,000.

When Peter Lynch says that “any event will go out of left fieldhe certainly wasn’t thinking of the COVID-19 pandemic that hit stock markets in March 2020 or Russia’s invasion of Ukraine in February 2022. These are precisely the kinds of unpredictable events that occur sporadically and cause the stock markets to fall. But in the long term, such events become less important in the face of the almost uninterrupted march of economic growth and corporate profits. Watch the evolution of the Dow Jones Industrial Average index from 1994 to today and try to identify the crises that caused it to fall:

In my opinion, the main falls in the index since 1994 correspond to the following crises:

– 1998: Russian financial crisis (default on domestic debt and devaluation of the rouble)

– 2000: Bursting of the technology bubble

– 2001: September 11

– 2008-2009: The American financial crisis

– 2020: COVID-19 pandemic

– 2022: Russian-Ukrainian War

Over the long term, corporate profits will continue to grow, and stocks will follow this progression fairly faithfully.

Philippe LeBlanc, CFA, MBA
Chief Investment Officer at COTE 100

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