Skip to main content

Sound Advice: September 1, 2021

It’s All About The Earnings 

For stocks, the key driving force is EPS, earnings per share. EPS is the same thing as profit or net income per share.  Over time, when a company’s earnings are rising, its stock will follow.  The two are not always in lockstep, but most assuredly they will move in the same direction.

There are nuances that impact current stock movements and probable price action ahead.  Among the most important is the price-earnings ratio.  It’s also known on Wall Street as the P/E, the price-earnings multiple, the multiple, the valuation rate, and the capitalization rate.

The P/E is derived from a simple calculation.  The P stands for the price of one share of stock.  The E stands for earnings per share, which is the company’s net income divided by the number of shares outstanding.  EPS and P/E information is available on many financial websites including Yahoo! Finance and MarketWatch.

By itself, the P/E is not helpful.  What’s missing is the historical range of P/Es for the company’s stock and well as the prospective growth rate of that company.  Typically, the higher the growth rate, the higher the P/E.

The relation between the P/E and the growth rate is put in perspective by the PEG ratio, which is derived by a simple calculation: P/E divided by the company’s prospective growth rate.  So if the P/E is 20 and the growth rate is 10% a year, the PEG is 2.0.

PEG ratios tend to vary widely.  In rare cases, there are PEG ratios below 1.0, but those are usually cyclical companies whose results tend to follow boom and bust cycles.  The other extreme is high growth companies for which investors often ignore reality and expect the best possible outcome.

A productive investment approach is to seek stocks with PEG ratios toward the lower end of the scale, topping out at no more than 2.0 to 2.5.  During periods of market strength, this will require considerable diligence, but when the stock averages are slumping, better values will be widely available.

There’s more.  Although there’s an extraordinary amount of investment information at one’s fingertips today, that wasn’t always the case.  Before the introduction of the Apple II and IBM PC computers, companies were far more close-mouthed about how their operations were going.  Fast forward to today, the pendulum has swung far in the direction of transparency.  Many companies now provide ongoing guidance about their pace of business and the impact on their earnings.

Not surprisingly, there’s a wrinkle here.  In addition to the earnings guidance provided by company management, there’s also something known as the whisper number.  That’s the number bandied about by Wall Streeters, which may or may not be the same as the target the company is shooting for.

If the earnings guidance number and whisper number are the same and the company’s actual earnings (and sales) are in line with those numbers, there’s unlikely to be a major impact on the stock.  But if there’s a shortfall below the whisper number (when it’s higher than the guidance), the stock may plunge.

All of which points back to the same thing: Over time, stock prices are driven by changes in underlying earnings.  During shorter periods, however, investor psychology rules the day.

N. Russell Wayne, CFP®

Sound Asset Management Inc.

Weston, CT  06883

 203-222-9370

www.soundasset.com

www.soundasset.blogspot.com 

Any questions?  Please contact me at nrwayne@soundasset.com

Comments

Post a Comment

Popular posts from this blog

Sound Advice: September 30, 2026

Now what? For many women, there comes a time when financial confusion reigns.   It may come after a spouse passes or a marriage goes off the rails.   It’s the same situation for women who never married. The questions are many.   The answers may be few.   Toward the top of the list of concerns is the issue of understanding.   Although there are always complex matters, it’s essential that all of the elements are clearly presented in a straightforward fashion.   There’s more.   Presentation is one thing, but comprehension is another. If there’s a question, it must be asked.   Clarity is the key.   Don’t just say I get it when you don’t.   And, it’s essential to grasp how each of the items fits in the overall situation. In the absence of understanding, no decisions will be made. Here are some of the most pressing questions? What’s the smart way to handle my investments? Where should I go for advice? A bank, stockbroker, attor...
Post a Comment
Read more

Sound Advice: September 19, 2026

Is AI good news or bad news for investments? AI is potentially very good news for investors—but not automatically good news for every investment . The key distinction is between AI as an economic technology and AI stocks at today's prices . As of September 2026, there are compelling reasons for both optimism and caution: The bullish case: AI spending remains enormous. Gartner estimates global AI spending at $2.7 trillion in 2026 , up 49.5% year over year. If AI produces sustained productivity gains, corporate profits could expand well beyond the companies currently selling AI hardware. The valuation case: Investors have already priced in a lot of success. Valuations of major AI companies are elevated and expected long-term earnings growth is well above historical norms. The spending-risk case: The five largest hyperscalers are expected to spend more than $1 trillion on AI-related capital expendit...
Post a Comment
Read more

Sound Advice: October 14, 2026

Why your adviser must be a fiduciary   You should insist that your financial adviser be a fiduciary because a fiduciary is legally obligated, when acting in a fiduciary capacity, to put your interests ahead of their own and manage conflicts of interest appropriately. Key reasons: Your interests come first. A fiduciary duty requires the adviser to act in your best interest rather than simply recommending something that is suitable or profitable for them. Fewer conflicts of interest. Some advisers can receive commissions, bonuses, or other compensation for recommending particular investments or insurance products. A fiduciary must address material conflicts rather than allowing them to drive the recommendation. Greater transparency. Fiduciary advisers generally have obligations concerning disclosure, fees, conflicts, and how they are compensated. That makes it easier for you to understand what you're actually paying. Better alignment over the long term. A good adviser sh...
Post a Comment
Read more