Home » Stocks Are Undervalued and May Have Even Further To Rise

Stocks Are Undervalued and May Have Even Further To Rise

Stocks Are Undervalued and May Have Even Further To Rise

This column is my opinion and expresses my views. Those views can change at a moments notice when the market changes. I am not right all the time and I do not expect to be. I disclose all my positions clearly listed on the page, and I do not trade my account on the stocks spoken of in this column unless fully disclosed. If that does not work for you stop reading and close the page. Do not bother me or harass me.

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Stocks have seen a significant rebound since the Christmas Eve disaster.  The S&P 500 has risen almost 14% and is now down about 9% from its highs. Unlike the stock market, forecasts for 2019 earnings estimates continue to drop. As of January 17, data from Dow Jones S&P Indices estimate that earnings will climb to $169.61 per share in 2019 up 8.1% from 2018 estimates of $156.89.

(Data From Dow Jones S&P Indices)

Trending Lower

Estimates for 2019 have been steadily falling since August when they peaked at $177.07, falling 4.2% since then. The trend of lower earnings growth in 2019 is something that is likely to continue for some time, but the big unknown is just how far they could fall. It is still early in the first quarter earnings season, but with 10.5% of companies in the index reporting, 73.5% have beaten estimates while 19% have missed estimates, and 7.5% met.  If the trend continues, it will result in the lowest beat rate since the second quarter of 2017, and the highest missed rate since the third quarter of 2017.

 

Energy Is The Big Problem

A significant reason estimates in the S&P 500 are falling is due to the fall in oil prices. Factset data shows that earnings estimates for the energy sector for the first half of 2019 have fallen 30%.  The second biggest reduction in earnings estimates have been the technology sector at 7.2%

energy sector

(Factset)

It is entirely possible that throughout the next several week’s oil price continue to recover, and that would help to stabilize the earnings outlook for the sector and the broader equity market. Should oil prices stabilize or continue to rise it is likely to be positive for the equity market.

It also isn’t entirely clear how much estimates for 2020 need to come or if they do need to fall. Estimates would suggest earnings growth of nearly 14% versus 2019 estimates. A healthy growth rate, which would indicate the current PE ratio of 13.8 is less than the 2020 earnings growth rate.

Still in many ways, even with the recovery in equity prices, we can always argue that the S&P 500 still has further to gain.  When we look closer, we can see that the year/year returns in the S&P 500 are the lowest since 2008, despite earnings growth only slowing forecast to slow to 8%.  In 2015 and 2016 the S&P 500 had a year over year decline of 2.65% in the third quarter and earnings contracted by 9%.

Expectations

It would suggest that stock prices are preparing for something that may be far worse than what current estimates would suggest. In the past when the market has pulled back this steeply it has resulted in earnings contracting. To this point that is not widely expected to happen.

(Data From Dow Jones S&P Indices)

Bargain Basement

Additionally, the S&P 500 is trading at 15.8 times 2019 earnings and 13.9 times 2020 earnings estimates. Since 1988 the PE ratio has averaged 17.6 times next twelve months earnings, with a standard deviation of 5.1, a range of 12.5 to 22.75.

The PE ratio over the next twelve month would suggest that the valuation is at the low-end of the range and near a bottom. 

(Data From Dow Jones S&P Indices)

It would seem at this point the market has priced in a scenario that may not be likely to happen, while valuations have fallen to bargain basement prices.

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Mott Capital Management, LLC is a registered investment adviser. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Upon request, the advisor will provide a list of all recommendations made during the past twelve months. Past performance is not indicative of future results.