Earnings Growers Don’t Look Expensive vs Market, by Terry Gardner – YouTube Video & Transcript

In this video, Terry Gardner discusses the current stock market narrative, analyzes earnings per share growth on a two-year stack, and compares sectors and stocks on a P/E-to-growth rate (PEG) basis.

 

 

 

 

 

 

https://youtu.be/B7mtrxhCZsw

Video Transcript

Terry Gardner:

Hey, good afternoon, everyone. It’s Terry Gardner from C.J. Lawrence. It’s Thursday, September 24th. It’s been a while since our last video. So I thought I’d come back to you today with some of our current thoughts on the US equity markets. Hopefully in the meantime, you had the opportunity to view the videos from my colleague at C.J. Lawrence Bernhard Koepp. If you haven’t seen those, they’re archived on our YouTube channel. So you can visit the C.J. Lawrence, YouTube channel to view those and all of our previous videos and commentaries.

Terry Gardner:

And yes, I’ve got teenage daughters and they’re appalled that their dad has a YouTuber, but that’s for another day. We want to talk about three things today. We want to comment on the current market narrative and where things stand in terms of sentiment and the underpinnings for the market. Two, we want to talk about earnings growth, and we want to introduce the concept of the two year stack. And then thirdly, we want to reintroduce a ratio that seems to have lost favor a bit, in the current market discussion, and that’s the P/E-to-growth rate.

Terry Gardner:

So first off, where we stand today in terms of the market, we’ve given that quite a bit of the gain that we saw over the past several months. In fact, the S&P 500 is about flat for the year. We’re down about 4.5% for the month or over the last 30 days. So you can see, we’ve had some market volatility and some fluctuation, much of that has been news flow driven. So what we are thinking now, is that the market is going to have to go through a period where it is going back and forth between digesting fundamentals and digesting sentiment.

Terry Gardner:

So the sentiment issues are real. We’re facing them every day. So to my first point, where is the market narrative? I think what has shifted in the discussion about the market is, is a couple of things. One is the likelihood of another fiscal stimulus bill. Now there’s some chatter today, that maybe there’s some small bite-sized packages that could be pushed through, but it’s clearly gotten more difficult in Washington for the legislators to push through another fiscal stimulus bill.

Terry Gardner:

Funding the government, you may have seen this past week, there was a continuing resolution which funds the government through December 11th, but that sets up another major battle to fund the government thereafter, in December. Clearly, there’s going to be some election uncertainty, both at the President, Senate and House of Representative levels, so that will create some pushes and pulls in the marketplace. And we’ve seen an uptick in COVID cases, globally.

Terry Gardner:

I think that was probably to be expected as we got into the fall, but the reality is here, we’re seeing the cases, and so that percolates into the market and dampens sentiment a bit. At the same time, I think the narrative around a vaccine has shifted a bit and extended a bit, where the likelihood of a vaccine being available to the general population, that timeline has probably pushed out into 2021, where I think earlier in the year, some had hoped that it would be a 2020 event.

Terry Gardner:

At the same time, there’s still some very good things happening, underpinning the stock market. The global growth is picking up and we’re certainly seeing that in not only developed economies, but in some emerging economies. Interest rates remain very, very low, so there’s very little competition for stocks from fixed income instruments and inflation is tame. Inflation being tame and interest rates being low, is an important underpinning for stock market valuations. We’re going to talk about that in a second. Then finally, businesses are reopening, albeit slowly, but that reopening process lends to a positive narrative for the markets.

Terry Gardner:

So if you followed our work over the months and years, you know that we’re very focused on earnings growth for the companies in which we invest and not only the predictability, but the magnitude of that earnings growth. So we conducted some analysis, because 2020 is clearly an odd year, in terms of analyzing earnings growth. There’ll be some companies that will have very depressed earnings in 2020, that will look like they’ve got a major jump in 2021. So what we wanted to do was take a look at the two year stack. Our point number two, and the two year stack is simply, what do earnings look like in 2021 versus 2019, on kind of a more normalized level?

Terry Gardner:

So we did that analysis to see where the growth was coming from within the S&P 500 and there were some really interesting conclusions. First of all, the number of companies that have negative comparisons over two years, surprised me to the upside of bit, in fact, and I’m just opening my statistics page here. There were 316 of the S&P 500 companies, are going to have positive earnings comparisons between 2019 and 2021, but 184 are going to have negative comparisons. So that’s over two years, earnings will still be down for those companies. And what that’s setting up is, there’s clearly a market where there’s some haves and have nots, and we can talk about valuation in a second, in terms of how you value that growth. But it’s important to realize, as we look at the number of companies that do have that earnings growth, their scarcity value there, and that’s going to feed into this discussion about valuations.

Terry Gardner:

So the next point, and by the way, when you look at sectors and where the earnings growth is, it’s clearly in technology and communication services and healthcare, that’s where the two year stack growth is. So when you hear discussions about the market and stocks being overvalued, that discussion is oftentimes taking place without the consideration, “Okay, but where is the growth?” And that leads us to this, our third point, which is the P/E-to-growth ratio. It’s a ratio that was used, oftentimes in the ’90s and the early 2000s, the PEG ratio, it was often referred to. And all it does is, it puts the price earnings multiple over the earnings growth rate of the company to create a ratio. Are you paying up or are you paying down for growth? And so we ran that analysis for all 500 companies using the two year stack.

Terry Gardner:

So we looked at earnings growth between 2019 and 2021, and then we put the current multiple on 2021 earnings on top of that, to see where were there values in the marketplace, where you were paying a reasonable price for good earnings? And it was very revealing, because you often hear how expensive the leaders in the market have gotten, the top five, the mega caps, the big tech companies that are responsible for the pushers in the poll of the index, because they have such a high weighting, but the bottom line is, that’s where the growth is.

Terry Gardner:

So our view was confirmed, that you want to stick with growth, even if you’re paying slightly higher premiums, because that growth is worth paying for and it’s scarce. And by the way, when you do this analysis, you realize, you’re actually really not paying that much for the growth that you’re receiving by investing in those stocks. I’m going to throw a couple of statistics at you real quickly, and then we’ll wrap it up.

Terry Gardner:

But the S&P 500 is trading at about 19.5 times, 2021 estimates. Okay? The growth rate on the two year stack for the index, is about 2%. So you’re paying 19 times for 2%, two year growth, that’s the market. Okay? When you break that down into sectors, you find much more attractive situations, and I’m even going to go into some stocks. But technology is trading at about 23.5 times, 2021 estimates, but you’re getting 19.5% growth, so pretty close to a 1 times PEG ratio.

Terry Gardner:

For communication services, which is an interesting one, because you’ve got the social media companies in there, like Google and Facebook, but you’ve got slower growers like the telecom companies and media companies in there, as well. That sector is trading about 20.8 times, for 5% growth. So you got to be careful in that group and pick and choose. Healthcare looks very appealing. That sector is trading about 15.2 times for 17%, two year stock growth. So below 1% PEG ratio, that’s noteworthy.

Terry Gardner:

How does that compare to the other sectors? On the other end of the spectrum? Industrials are trading at 20 times and earnings for the sector are going to be negative, 2021 versus 2019. So you’re paying 20 times for negative earnings growth. And for consumer staples, another defensive cyclical group, you’re paying 20 times for 1% growth. So you can see the dichotomy between the growth sectors and what you have to pay for that growth, versus some of the more cyclical sectors and what you’re paying for, what is essentially, no growth or in some cases, negative earnings growth.

Terry Gardner:

How about the names at the top? So everybody wants to know, “Well, what stocks? What about these big five, heavyweights in the S&P 500 and how do they stack up in this analysis?” So it’s interesting. Again, remember the S&P 500, the index, trading at 19.5 times for 2% growth. Okay? Which is about a 9 times PEG ratio. Apple trading at 0.8 PEG ratio, Microsoft 0.86 PEG ratio, Amazon 0.8 PEG ratio, Google 1.29, so a little higher, above 1, but still pretty reasonable. Facebook 0.44, J&J, an interesting one, .28, Nvidia 0.32.

Terry Gardner:

So talk about these high flyers and people get on TV and talk about stocks up huge, valuations are unreasonable. When you take that price in the context of its earnings growth, some of these stocks look a whole lot more reasonable than the rest of the broader market. And just to wrap it, up Adobe 0.49, PayPal 0.33. So there’s a couple of examples of heavyweights in the index and how relatively inexpensive they are versus the rest of the market, on a price to earnings versus growth rate analysis.

Terry Gardner:

I hope that’s helpful. Happy to share that analysis with you. I’m getting a lot of applause from the canines in the background here. So I guess it was a good video today. Trying to keep these a little bit shorter and maybe more frequent. If you have any questions, give me a shout, 212-888-6403. Or shoot me an email at tgardner@cjlawrence.com. Have a great Friday and weekend.