value
Return = earnings plus a mood swing
The rule
Your long-run return has two parts: the real growth of the business, plus the change in the price the crowd will pay for it.
Where it flips
In the short run the mood part can rule and reward you for buying hype, until it does not. The fix is to anchor on the real return you can actually earn, and treat any P/E rise as a bonus you must be ready to give back.
Over time a stock's return splits in two. One part is the real return: the earnings and dividend growth the business actually delivers. The other part is the mood return: how much the crowd is willing to pay, the P/E, going up or down. The first is real and lasting. The second is pure feeling, and over long stretches it tends to cancel out. Mix up the two and you will mistake a mood swing for real performance.
A worked example
A share doubles: profits rose 30% (real) and the P/E jumped from 15 to 23 (mood). When the mood cools and the P/E falls back to 15, most of the gain vanishes even though the business kept growing. [illustrative]
How to spot it
- ·gains driven by a rising P/E, not rising profit
- ·a mood swing mistaken for real business performance
- ·paying up because "it always goes up"
John C. Bogle · Value investing writing