Low-Interest Rates Do Not Justify The Egregious Earnings Multiples

Low-Interest Rates Do Not Justify The Egregious Earnings Multiples

Excerpt from Stanphyl Capital’s letter for the month of October 2018 discussing the impact of low interest rates on the earnings multiples and the housing market.

As noted in recent letters, through this entire bull market low interest rates were used to justify egregious earnings multiples on stocks, as well as creating those earnings via cheap mortgages, auto loans, debt-financed stock buybacks, etc., and yet now those rates are climbing. The result will be compressed corporate earnings multiples and a slowing in the all-important housing market…

From The Archives: Apple IPO Original Document

Today, Apple is the largest public company in the world, and the group’s iPhones can be found in stores all over the globe, but not long ago the company was a baby when the Apple IPO was filed in the 1970s. Not only is Apple the world’s most valuable company, but it’s also arguable that Read More

Earnings Multiples

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Q3 hedge fund letters, conference, scoops etc

…and in auto sales…

Earnings Multiples

…while the liquidity withdrawal of the Fed’s quantitative tightening continues, with an October increase in the roll-off to a targeted $50 billion a month (although it’s running slightly lower due to fewer mortgage refinancings). Also in October the ECB cut its monthly printing from €30 billion to €15 billion and will eliminate it entirely in January. (See additional color later in this letter re our BNDX short.) The 10-year U.S. treasury yield has definitively broken its long-term downtrend and now sits at over 3.1%, at least in part due to a soaring budget deficit causing a record amount of issuance, while the 2-year yield of over 2.8% handily bests the S&P 500’s approximately 1.7%, thereby presenting an attractive alternative to an index priced at approximately 22x trailing GAAP earnings. Meanwhile, a nearly flat 2-10 curve and recent slowing in global and U.S. growth…

Earnings Multiples

…and ongoing trade wars are indicative of a looming economic slowdown beyond the housing market cited above, while steady inflation and the aforementioned budget deficit may mean rates continue to rise, thereby compressing profit margins and increasing corporate defaults. Stocks should soon begin pricing in 2019 earnings and compared to 2018—unlike 2018 vs 2017—they won’t be advantaged by year-over-year tax cuts, making for much tougher comps. Thus, I continue to believe that the catalysts are here for the high-multiple stock party to end.

Thus, although we booked some profits in this month’s Russell 2000 plunge and thus reduced the position size (I’ll likely enlarge on a significant rally), we remain short that index (via IWM), which—despite this year’s tax cuts and fiscal stimulus and October’s big correction—still has a trailing GAAP PE of nearly 50 and a near record-high debt-to-EBITDA level of 3.5x (vs. 1.8x for the S&P 500). Again, I’d far prefer to be buying microcap companies than shorting them, but I’m a deep-value guy and in this environment I’m still not seeing any deep (or even shallow) value out there. When it returns we’ll be the guys with the lowball bids that are suddenly getting filled.

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Jacob Wolinsky is the founder of ValueWalk.com, a popular value investing and hedge fund focused investment website. Jacob worked as an equity analyst first at a micro-cap focused private equity firm, followed by a stint at a smid cap focused research shop. Jacob lives with his wife and four kids in Passaic NJ. - Email: jacob(at)valuewalk.com - Twitter username: JacobWolinsky - Full Disclosure: I do not purchase any equities anymore to avoid even the appearance of a conflict of interest and because at times I may receive grey areas of insider information. I have a few existing holdings from years ago, but I have sold off most of the equities and now only purchase mutual funds and some ETFs. I also own a few grams of Gold and Silver

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