By Tim Courtney, Chief Investment Officer
Investors today have easy access to helpful data like earnings and growth, but the market news headlines often give minor mention of these fundamental data points. Instead, the media’s attention has focused on favored themes like Federal Reserve actions and AI buzz over the last several years. Aside from a few names like Microsoft or Nvidia, which grab headlines due to their size and dominance in the U.S. market, earnings from companies that make up a majority of our economy and employ millions of citizens have taken a backseat. But the products and services provided by these companies and the earnings produced from them are the reason we invest in the first place.
While some stock investors or speculators may benefit from short-term moves driven by interest rates changes or the latest news surrounding AI (and many of them may be harmed by short-term moves too), long-term investor returns hinge on two key factors: the price paid for a stock today and the company’s future cash flows from earnings.
Looking at earnings, S&P 500 profits have grown a little over 7% per year since the start of the pandemic and 7% per year over the last decade. Mid cap companies have seen their profits grow 10% per year since the start of the pandemic and 10% per year over the last decade. For small caps, their earnings have grown 18% and 10% respectively.1 The earnings growth numbers over these periods for each market segment are slightly higher but very close to their long-term averages.
While these earnings growth numbers look relatively steady over time, they of course are not. A pandemic, a banking crisis and multiple recessions make year-by-year earnings numbers jump around wildly. We can make a guess about how much future earnings will grow, but it is still a best guess about an uncertain future. For individual companies the uncertainty of future earnings is even higher. But while we can’t know what future earnings will be, we do know the current price of a stock.
Current prices provide us with insight into what kind of guesses investors are making about uncertain future earnings. Many large-cap growth companies, like Nvidia, are priced at a premium – as investors guess monumental earnings are almost assured over the next decade.2 If earnings are monumental, then the price may be justified. But if earnings are anything less, the current price is likely not sustainable. There is risk for a company that is priced to hit home runs every time they come to bat for a decade as history tells us the odds of doing so are low.
Since we can only guess at future earnings, we recommend holding diversified portfolios and making investment decisions based on current prices – something we can know. Having a diversified portfolio means having exposure to some higher priced companies to be sure, but it also means having exposure to companies that don’t require the future to work out exactly as investors expect – since it rarely does.
If you have questions about this, please contact your Exencial advisor.
Sources
- Standard and Poors (data as of 10/11/24) – S&P 500 Index Earnings; Operating Earnings for S&P 500, S&P 400 (Mid Caps), and S&P 600 (Small Caps); Earnings data for S&P 500 goes back to 1988, Mid and Small Cap data goes back to 2008.
- Fortune (6/12/24) – Nvidia stock forecast: After rising more than 200% in a year the chipmaker could be fabulously profitable, an AI leader—and an extremely poor investment
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The S&P 500® Index is widely regarded as the best single gauge of large-cap U.S. equities. The index includes 500 leading companies and covers approximately 80% of available market capitalization.
