I see so many comments on here anytime the market drops like “stocks are on sale” or “if you loved stocks last week, then you should love them even more this week,” which seem to focus only on the price, without understanding what the price of a stock or the market consists of: future earnings expectations.
Just because the price of a stock was X last week doesn’t mean that price has any relevance to the price this week. And just because a stock rose 100% last year, doesn’t mean that the stock is any more or less attractive today based on its past history, at least from a fundamental perspective.
When you are only factoring in past prices (without analyzing new, forward-looking information) you are engaging in anchoring, a psychological concept that overweights initial information you are presented with.
Here is a relatively concise analysis of the current market’s outlook from Frank Curzio, who like every analyst, has had his hits and misses, but is usually quite bullish that actually displays analysis based on new information related to earnings. I would link, but this came from an email update.
According to Capital IQ, S&P’s research division, companies in the S&P 500 are expected to generate a combined $181 in earnings per share (EPS) in 2020. That’s 14% higher than the $159 in combined EPS the S&P 500 generated in 2019.
Now that the coronavirus has spread… there’s no way earnings are growing 14% this year. In fact, Goldman Sachs—which once called the virus a ”short-term problem”—just published a report saying earnings will not grow in 2020.
I think this is conservative, given the number of companies that have lowered earnings over the past two weeks (including Apple and Microsoft, two of the biggest names in the S&P 500). But it’s important that investors understand these numbers.
If we see no earnings growth in 2020… that means 2020 earnings will come in at $159 a share, at most. But if we divide the current price of the S&P 500 (about $3,050) by the $159 in combined earnings… we can see that the S&P 500 is already trading at 19x forward earnings.
In other words, even though the market pulled back more than 10%… the S&P 500 is still trading like there’s no coronavirus. (Remember, earnings are falling alongside the markets… that’s why the market is still expensive despite its 10% correction).
At 19x forward earnings, the markets are still pricing in significant growth. Yet, earnings probably won’t grow at all in 2020…
What does this mean?
There’s likely another 20% downside from here.
With no actual growth forecast for 2020, the market should be trading closer to 15x—the 10-year average… and more than 20% lower than current levels.
Of course, this downside could be limited if we find a vaccine for the coronavirus in the short term… or if we see massive government intervention to help backstop the markets. (Things like lowering interest rates, preventing short selling, or injecting cash directly into the markets.)
So anytime someone says stocks are on sale, or cheap, or a good time to buy, you should ask them, “what are you basing that information on?” The fact that the price is cheaper than it was last week/month/year means nothing without understanding the earnings picture.
Disclaimer: This information is only for educational purposes. Do not make any investment decisions based on the information in this article. Do you own due diligence.