Earnings growth will drive share prices over time. So, even if you wildly over-paid for stocks in 1999 (which I am not support of that idea), earnings growth eventually bailed you out. If you look at a few of the bad boys from that era, like Microsoft (MSFT), Cisco (CSCO), or Walmart (WMT), you’ll find some patterns. Let’s take a look.

So we are just going to skip right past my kindergarten quality mark-ups - okay? If we look at the orange line as an estimate of business value and the black line as the monthly closing price for this business - which happen to be Microsoft - you’ll see how over-valued the share price traded relative to the earnings value of the company. It is the area marked with red squiggles. You should also notice that the EPS consistently went up from 2000 to 2008. The fact that earnings grew over this time allowed the business worth to catch up to the quoted stock price. Now the price one paid was two-fold: frustration and emotional pain had to turned over to the market gnomes.

And now, we can get into the purpose of this blog post. The graph above is a high-quality utility stock. As S&P earnings growth peaked in 2000, astute investors know to rotate the portfolio of holdings to companies that positively respond to the new business conditions. While the TV and other ignorant market talking-heads are screaming "buy the dip type of non-sense or buy and hold,” (hmmmm, these all seem to be “buy” focused) it should become very apparent that you have no process. A process should include, but is not limited to: what to buy, when to buy, when to sell, and what to do with the proceeds. A key part of you process should include factors. A factor is simply a quality or characteristic of a company or a group of companies. You can back-test or simply take notes for your future investment decisions as to what type of companies perform during what kind of economic or business conditions. One factor could be as simple as what sector of the economy the business is located.

So simply just using a factor model (which I would not recommend), you can see by rotating out of technology and into utilities would have been a good financial decision - right? Why is that? Under what business conditions favor utility stock over technology stocks? Are there business conditions where both utility stocks and technology stocks do well? The point is business conditions change over time because there is a cycle. As a professional, I monitor the business conditions so that I can manage risk. Let me repeat this; I am managing business conditions so that I won’t get run over by a bus that will back up and run over me again! While the TV pundits and wealth managers like to sell you products to make you money, true market pros always approach risk first.

Let’s finish up with our fact set data at the very top of this post. They show S&P earnings growth coming in at a -0.5%. It is a fair comment to say this is better than consensus. It is also a fair comment to say that we’ve now gone from +24% to +12% to now -0.5% growth the past three quarters. Not only that, but our comparable quarters are about to run into a brick wall. Fact set also did a nice job in breaking out a potential factor to be incorporated in our process. It shows earnings growth based on what percentage the companies revenue is US or foreign. There is a big divergence there. Big divergences can lead to out sized results for those paying attention. At a minimum, it should be a heads-up to know what percentage of one’s portfolio is comprised of businesses that derive a large percentage of their revenue outside the US. Some other company factors to consider would be levels of debt, beta, yield, and market capitalization.

Happy Returns!

P. Franklin, Jr. CEO

All opinions and estimates included in this communication constitute the author’s judgment as of the date of this report and are subject to change without notice. This communication is for informational purposes only. It is not intended as an offer or solicitation with respect to the purchase or sale of any security. This information is subject to change at any time, based on market and other conditions. Any forward looking statements are just opinions – not a statement of fact.

Investing may involve risk including loss of principal. Investment returns, particularly over shorter time periods are highly dependent on trends in the various investment markets. Past performance does not guarantee future results.