At J.P. Morgan’s recent third quarter results call, Jamie Dimon, Chairman and CEO, was asked about comments he had made about the supply chain problems easing and what he had been hearing from around the world about the potential for logjams to open up. This is what he said:
I’m not hearing much different than you’re hearing. I know that the overfocus over time is so extraordinary sometimes from the press that people forget the big picture. The economy is growing 4% or 5%. There’s not one company I know that’s not working aggressively to fix their supply chain issues. Sales are still up – credit card, debit card spend still up – consumers in great shape. And capitalism works. I doubt we’ll be talking about supply chain stuff in a year. I just think that we’re focusing on it too much. It’s simply dampening a fairly good economy, it’s not reversing a fairly good economy.
We are with Jamie Dimon, who has steered J.P. Morgan successfully through the ups and downs of economic and financial crises over the past twenty years and has made it the world’s biggest bank by market capitalization: We should not overfocus on short-term issues. J.P. Morgan reported strong results and offered a first-hand look at what is going through its consumer and corporate lending businesses. There is of course great uncertainty as we go through the transition from the covid pandemic and the supply chain problems will have an impact. However, the underlying forces are in place and so if the pandemic can be contained and the link between infection, hospitalization and severe outcomes weakened or broken, as appears to be the case so far, we should look forward to next year and the recovery with optimism.
There is short term focus too on markets and valuations. Many investors are worried that market valuations are too high or that there could be a shift from growth to value stocks that would mean that the companies that have done well over the past several years will do badly going forward.
We invest in companies, not markets, and believe that there are many quality companies that are still attractively valued and will continue to deliver strong returns going forward. What do we mean by quality, though? For us it is all about the fundamentals: What do companies actually do, why do they do it well, is there demand for their products or services, and do they have the resources and the balance sheets to keep investing in their businesses and grow their sales, earnings and cash flows? That is what we mean by quality.
The key is that quality companies grow their sales, earnings and cash flows, and that stock prices follow fundamentals. A company that can grow its earnings by 15% a year doubles them every five years. Those earnings are the ‘E’ in the P/E or price-to-earnings ratio, so if the share price does not move, the P/E ratio halves. This means that a company that many think is expensive at 30 times P/E is cheap at 15 times over five years. Quality companies deliver those kinds of results not just over five years, but over ten and 25 years. Finding them is not easy, but that is why we have to do the work to analyse the fundamentals and make sure we have the right ones.
One of the reasons P/E ratios de-rate is inflation. Quality companies have the sustainable competitive positions to increase prices, the scale to absorb cost increases in their raw materials and labour, and the balance sheets to be able to get through the tough period in the middle, like right now, when costs go up but there is a lag before prices can be raised. This is when other companies go bust and quality companies get stronger by taking market share or buying their competitors. That is why quality companies can grow their sales and protect their margins. It is also why it does not matter if inflation means that interest rates go up and cause discount rates to go up too: if a company can grow its earnings at a significantly higher rate than inflation, its P/E multiple can de-rate like in the example above and investors can still generate attractive returns. This is also why it is almost impossible to find a five-year period in which shares have not gone up 8% a year, and why it is worth owning quality companies for the long term.