• Martin Sosnoff

Netflix In Penalty Box - Negative Indicator For Growthies

Suddenly, if wrong-footed on your numbers for a growth stock, the penalty is a snappy overnight haircut of 20%. Actually, this kind of markdown is awarded any stock that badly disappoints its following.

It could be Ford Motor or U.S. Steel, even General Electric, Goldman Sachs and JPMorgan Chase whose largesse can favor key employees, not shareholders. Amazon and Tesla do sag 5% intraday, but that’s understandable. Nobody dares sharp pencil his numbers here so you talk about growth in net free cash flow. Can’t put a multiplier on earnings per share. The number bears little relationship to the price of the stock.

In the financial meltdown of 2008 – ‘09, the market sold off to book value. The S&P 500 Index then yielded 5%. Nobody wanted to pay more than 10 times earnings for anything that walked. From where we trade today, a comparable markdown in valuation would approach 50%. As a reference point, currently, Amazon does fluctuate 4% intraday and ticks now 20% under its 52-week high. So much for conceptual stocks in a bear market.

Who cares? Nobody cares. Decades ago this was the expression we’d toss out on big down days. This table on price-earnings ratio valuation captures the nadir of sentiment and it’s not ancient history.

Back in the summer of 2001, the penalty for preannouncing quarterly numbers below analysts’ consensus had risen from 10% to 30%. Even Merck had no reserves left to pump into its numbers. Too many drugs coming off patent protection.

I’ve seen everything over the past 60 years. If you flanked 2 giant trash cans beside me, one marked right, the other wrong, both would be nearly filled to the brim. But, I’d cut my stupidities short and let right decisions sail on and on.

Summer of 2001, NASDAQ was in tatters and the economy stalled out. Democrats and Republicans were at odds on how to revive the setting. Nobody as yet wanted to deal with reality, that corporate earnings were crumbling. Proud blue chips like Procter & Gamble, McDonald’s and Coca-Cola struggled to grow their revenue lines. Tech houses made product pricing concessions. Management guidance was worth what it cost to splice into a corporate conference call. The S&P 500 Index eased below 1,200. (Now we’re over 4,300.)

Back then, I ran more numbers on tech’s destruction. The group still sold on the assumption that 2002 would be a strong recovery year. But, this was more a gut call with no back up. Carnage in the big capitalization names in the NASDAQ 100 Index proved widespread. It left many red faces among managements, analysts, even money managers.

Disbelief in growth stocks surfaced again in 2013 – ‘14. Apple sold at no premium to the market while Google sold at a 10% discount. There was no premium paid for drug houses like Merck, Eli Lilly and Bristol-Myers Squibb. Microsoft sold at a 10% market discount with Cisco at 20%. The premium paid for Coca-Cola was just 10%. Everyone was skeptical that Coke’s franchise was intact or that industry R&D was sufficiently productive. The market sold at 17 times earnings. Still pricey.

Historically, when interest rates tick so low as presently, the stock market does sell at a high-teens price-earnings ratio. But, when long term Treasuries yield 4% or more valuation comes in to low teens. Consider, the current price-earnings ratio rests at 20 times forward numbers which assumes no recession. This insanity is now being corrected.

Deep basic: A contraction in earnings is a fair assumption even as interest rates are put up by the FRB. For serious players, this is a wait ‘n’ see kind of situation. Let somebody else own Amazon, Alphabet and Tesla.

My old friend, Barton Biggs (now gone) once analyzed relative strength of industry groups over a 25-year period. What Barton found was that there was only 1 chance in 4 that a group that was in the top 20th percentile would repeat the following year and only 1 chance in 7 it would maintain primacy in year 3.

I’m betting Amazon and its ilk are yesterday’s newspaper. The owners of the Dow Jones Industrial Index pulled a fast one when they made UnitedHealth Group numero uno in individual stock weighting. But, UNH is as far from an industrial as you can move, and I like it. Dow Industrials now are weighted in growth stocks, not U.S. Steel and its ilk. Times change.

Think about it. One historical yardstick for measuring stock market performance by design has lost its historical relevance. I went out and bought more Morgan Stanley and Exxon Mobil. At the least, they were analyzable and Exxon still yields more than a junk bond.

Market exuberance historically gets overdone. Price-earnings ratios going back to early postwar years show great volatility: The market rarely has sold above 15 times earnings for very long. Deep recession in 1973 – ‘74 took the market below 10 times earnings, and again, early eighties when Paul Volcker fought inflation.

A retraction in the price-earnings ratio for the market is around the corner, sizable, maybe overdone.

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