Update - August 22, 2023
A Sprinkle of Common Sense in This Market
I’ve had a strange feeling for a while now. I’m sure you’ve had it too.
It’s this sense that something’s not right… or even broken… with this market. And I’m not just talking about the price action over the past few weeks.
It actually goes much deeper than that.
So far, more than 85% of S&P 500 companies have reported second quarter earnings. And the numbers don’t look too hot.
The index is on track to report its largest year-over-year earnings decline in almost three years. And this is the third straight quarter of declines… a continuation of the earnings recession that has been ignored all year.
On top of this… many stocks are now trading far above their true values.
A quick glance at the CAPE ratio – think of it as a better version of P/E that uses 10 years of inflation-adjusted earnings – shows that S&P 500 stocks are foolishly overpriced.
Right now, the CAPE ratio is sitting around 30… about 80% higher than its historical average.
To put that into perspective…
Stocks are more expensive right now than they’ve been 95% of the time throughout history.
Common sense tells us that the more you pay for something, the less bang you get for your buck.
This is as true in the stock market as it is anywhere else.
Common sense also tells us that three consecutive quarters of declining earnings doesn’t bode well for all of this “soft landing” talk. Our economy is in more trouble than folks want to admit.
The earnings decline also explains the price action we’ve seen lately. It’s a sign that investors are finally getting spooked.
The real question, though, is… what does all this mean for us?
Well, here’s what it doesn’t mean…
We won’t be throwing the baby out with the bathwater. Investors should not jump ship.
There are plenty of quality stocks out there… even now.
What it does mean is that we must be more selective about the stocks we invest in. We can’t rest assured that a rising tide will lift all boats.
This means we need to look for companies that are generating strong cash flows… are operating with as little debt as possible… have excellent growth prospects in the years ahead…
And, of course, are trading at reasonable prices.
Just like our latest recommendation…
Sprinklr (CXM) is a business with immense growth ahead of it. It provides many of the world’s biggest brands with the insights and tools they need to engage with customers.
And it’s leveraging the transformative power of AI to improve its offerings.
Yet despite being in the high-growth tech industry, the company remains underleveraged in terms of debt.
Sprinklr holds just $17 million in total debt and has over $600 million in cash on hand. Its debt-to-equity ratio is a mere 0.03.
And the stock is trading at under six times sales.
All in all… it fits the bill perfectly. And there are many other stocks that do too.
We’ll use common sense to guide us.
It’s what we’ve always done… and what we should always do.
