Some Good News - Corporate Earnings

What drives stock market returns? Economic activity, politics, wars, viruses, inflation, interest rates...the list could go on. Over the long run, the answer is simply two things - (1) company earnings and (2) how much investors are willing to pay for those earnings.  

With everything that has gone on this year, some bright news is that corporate earnings have remained fairly stable, with 5.1% growth through the end of September.  What’s changed is how much investors are willing to pay for those earnings - a term known as “multiple growth” in the finance industry.

For example, if a fast-food restaurant earns $1 per share per year in earnings, what is an appropriate price for that stock? At certain times, investors may be willing to pay $20 for that share that produces $1 in earnings, and at other times only $10.

Investors buying at $20 may have expectations that earnings will rise in the future, which helps them justify paying more for the stock. 

Investors selling at $20 may have the opposite expectations, that earnings will not rise and may even fall. This seems to be the story of 2022.

Company earnings haven’t come down yet but investors expect them to. And that may very well happen in the coming quarters. But that may already be priced into the stock market since it is down before earnings have fallen. Could it end out being worse than expected? Absolutely. Could it be better? Sure.  

Proper asset allocation means positioning yourself so that if it’s worse than expected, you have enough reserves to weather the storm, and if it’s better, your long-term assets have exposure to a rebound in the stock market. 

Be a short-term realist and a long-term optimist. 

Happy Planning,

Alex

This blog post is not advice. Please read disclaimers.