The father of value investing, Benjamin Graham, explained this concept by saying that in the short run, the market is like a voting machine--tallying up which firms are popular and unpopular. But in the long run, the market is like a weighing machine--assessing the substance of a company. The message is clear: What matters in the long run is a company's actual underlying business performance and not the investing public's fickle opinion about its prospects in the short run.
Over the long term, when companies perform well, their shares will do so, too. And when a company's business suffers, the stock will also suffer. For example, Starbucks (SBUX) has had phenomenal success at turning coffee--a simple product that used to be practically given away--into a premium product that people are willing to pay up for. Over time, Starbucks has enjoyed handsome growth in number of stores, profits, and share price. Starbucks also has a respectable return on invested capital of over 20%.
Meanwhile, Sears (SHLD) has languished. It has had a difficult time competing with discount stores and strip malls, and it has not enjoyed any meaningful profit growth in years. Plus, its return on invested capital rarely tops 10%. As a result, its stock has bounced around without really going anywhere in decades.
The Bottom Line >>