🔬 The Fear of High P/E Stocks
Plus: LVMH blows up luxury; Consumers are stretched; and much more!
"Do not save what is left after spending, but spend what is left after saving"
- Warren Buffett
“Money is the best deodorant”
- Elizabeth Taylor
US equities ended mostly lower on Tuesday, weighed down by semiconductors and energy. Semiconductors dropped after weak guidance from ASML and reports of potential U.S. AI chip export limits. Energy stocks slumped as oil prices fell 4.4%, driven by reports Israel would not attack Iranian oil facilities.
Financials outperformed with solid earnings, while defensive sectors provided some support. Bank of America, Charles Schwab, and PNC rose on better-than-expected results, while Citigroup lagged.
Economic data disappointed, while Fed commentary focused on staying vigilant. The NY Fed Empire State Manufacturing Index dropped to -11.9, missing expectations of +3.0. Fed's Daly stressed the need for vigilance, urging against overanalyzing gradual Fed moves as inflation remains a key focus.
Notable companies:
ASML Holding (ASML) [-16.3%] beat Q3 revenue estimates but missed big on bookings, with 2025 revenue and margin guidance also falling short due to slower recovery in non-AI segments.
Advanced Micro Devices (AMD) [-5.2%] dropped after Bloomberg reported that the US may restrict AI chip exports to certain countries.
Citigroup (C) [-5.1%] beat Q3 earnings expectations but guided slightly lower on net interest income, with the CEO highlighting cost cuts and strong performance in the Wealth business.
More below in ‘Market Movers’.
Street Stories
The Fear of High P/E Stocks
Value Investing means so many different things to people. In my view, the rational form involves analyzing a company and only investing if you believe the intrinsic value (whatever the hell that is) is greater than the share price. In a fairytale, hypothetical world the two prices will one day converge, and you make a profit. Neat.
However, a more commonly cited version of Value Investing is the idea that cheap stocks (best typified by low trading multiples, such as Price to Earnings) are good, and expensive stocks (ie: high P/E stocks) are bad. Not neat.
The biggest fear in paying up for companies that trade at a premium is that one day that premium will disappear (this is called ‘a re-rating’). And it’s certainly a reasonable concern: As you can see above, even the best companies eventually see their multiples shrink.
In fact, if we look at the 25 stocks that traded at the highest P/E multiples back in 2014, 80% of them have seen their multiples decline. In the case of Amazon by an eyewatering 92%!
(Note: The above excludes Real Estate and Financial companies where P/E is often a bit wonky, as well a few outliers or companies with insufficient trading data.)
P/Es come down over time. Like a White Dwarf headed for Supernova, it’s just science.
The point I’m slowly working towards, however, is that that isn’t always a bad thing. A company often earns that high multiple by being excellent and whose growth prospects typically outpace said multiple contraction.
For example, the shares of the 50 highest P/E stocks back in 2014 have had an average annual return of 13.4% which is 51% higher than the 8.8% average for rest of the companies in the peer set. And thanks to the magic of compounding that means a 251% return vs. a 133% return. Again, science.
So sure, Amazon’s P/E might have dropped 92%, but it’s share price is +1,115% since then. Not a bad tradeoff if you ask me.
(Note: The above excludes Real Estate and Financial companies where P/E is often a bit wonky, as well a few outliers or companies with insufficient trading data.)
Beyond just share performance, Earnings Per Share growth points steadily in favor of high P/E stocks. That top decile included some companies that traded at multiples once thought to be comical, such as Meta, Palo Alto, Amazon and Netflix. But if you had the guts to hold them you would have had a return equally as comical (+677%, +961%, +1,115% and +1,153% respectively).
Most people try to get cute with their stock picking, buying low-P/E stocks and hoping that they will turn into high-P/E stocks. I hope you will also consider that buying high-P/E stocks and selling them when they are low-P/E stocks is equally as valid. You just want them to grow the ‘E’ a few hundred percent first.
LVMH Q3: We Can’t Have Nice Things
The King of Luxury posted its third straight quarterly miss on Revenue (€19.8B vs Wall Street estimates for €19.9B), seeing the price of their US ADRs drop 7.3%. The company called out continued deterioration in China as a main contributor and said it is pushing hard for cost controls, but matching that to declining sales has been a challenge.
All of its major divisions save for Perfumes & Cosmetics saw another sequential decline.
As the bellwether for the luxury goods space, this paints a pretty ugly picture for merchants of fancy things.
Consumer Expectations
The New York Fed’s latest Survey of Consumer Expectations wasn’t anything to write home about. Expectations for inflation 1 year from now remained frozen at +3.0% - obviously out of line with the Fed’s whole ‘rate cutting agenda’. While 3 and 5 year expectations both jumped (2.7% from 2.5% and 2.9% from 2.8% respectively).
Even more notable was the continued increase in delinquency expectations, defined as the probability of missing minimum debt payments over the next three months. In recent memory this level was only surpassed by the first few months of the Covid pandemic.
Punchline: Consumers aren’t as happy as the stock market may indicate.
Joke Of The Day
Research Analyst Motto: The less you say, the less you have to retract.
If you work in a bank you can’t bring home samples.
Hot Headlines
Bloomberg / Chip equipment maker ASML sees shares plunged more in 26 year history after reporting new orders around half that expected by analysts. As a bellwether for the chip industry this ain’t good news.
Reuters / Perpetually struggling pharmacy Walgreens plans to shutter 1,200 stores over the next three years in the face of struggling consumer spending and low drug reimbursement rates.
CNBC / Fresh off rating downgrade warning from S&P, Boeing announces plans to raise up to $25 billion to shore up balance sheet. The current machinist strike is reportedly costing the company +$1 billion a month, while the looming downgrade to ‘junk’ status would make it the largest company to ever reach that feat.
Bloomberg / Wall Street’s top banks kick off earnings season with massive recovery in trading and investment banking divisions. Global uncertainty seems to be leading to a particularly active time for investors, with the banks being the biggest beneficiary.
BNN Bloomberg / Risk modelling firm Karen Clark & Co. seeing Hurricane Milton costing insurers close to $36 billion. Remember when insurance used to be a sleepy but profitable business?
AP / Small-business uncertainty index jumps 11 points to 103 - the highest ever recorded - as economic and political concerns weigh on business owners.
Bloomberg / Russian fuel exports pop 16% to 843k barrels a day to hit 18-month high. India and China doing their bit to help a friend.
Trivia
Today’s trivia is on investing 101.
If a stock has a beta of 1.5, it is generally considered:
A) Less volatile than the market
B) More volatile than the market
C) Perfectly correlated with market volatility
D) Not correlated with market movementsIn finance, what is 'leverage'?
A) Vertical integration of operations
B) Increased profitability from reducing costs
C) Using borrowed capital for investment
D) The power of a CEO'Amortization' in finance usually refers to:
A) The increase in asset value over time
B) The division of a loan into smaller, periodic payments
C) The erosion of an assets value due to inflationD) The process of gradually writing off the initial cost of an asset
(answers at bottom)
Market Movers
Winners!
Wolfspeed (WOLF) [+21.3%] signed a non-binding agreement with the US Commerce Department for up to $750M in CHIPS Act funding.
Walgreens Boots Alliance (WBA) [+15.8%] crushed FQ4 expectations with strong retail pharmacy results and announced a plan to close 1.2K stores, which will boost earnings and cash flow.
Telefonaktiebolaget LM Ericsson (ERIC) [+13.1%] reported strong Q3 results, driven by North American network growth, though Q4 guidance hinted at weaker-than-usual seasonal performance.
Charles Schwab (SCHW) [+6.1%] beat Q3 earnings estimates with rising client cash flows and positive market engagement trends.
Doximity (DOCS) [+4.5%] was upgraded by Barclays, who see big growth potential in self-service ads and stable end markets.
PNC Financial Services Group (PNC) [+2.0%] topped Q3 earnings forecasts with better loan and deposit growth, along with lower-than-expected expenses and solid credit performance.
Losers!
ASML Holding (ASML) [-16.3%] beat Q3 revenue estimates but missed big on bookings, with 2025 revenue and margin guidance also falling short due to slower recovery in non-AI segments.
AppFolio (APPF) [-10.8%] was downgraded to underperform by Keefe, Bruyette & Woods, who expect revenue growth to slow in upcoming quarters, which might not be reflected in the stock’s valuation.
Coty (COTY) [-10.8%] lowered its FQ1 revenue growth guidance, pointing to weaker demand in mass beauty but expects a second-half recovery on the back of new product launches and easier comparisons.
CommVault Systems (CVLT) [-9.8%] was downgraded to neutral by Guggenheim, citing growth concerns, valuation issues, and weaker reseller performance.
Enphase Energy (ENPH) [-9.3%] was downgraded by RBC, who now expect slower growth next year due to shifting market conditions.
UnitedHealth Group (UNH) [-8.1%] posted strong Q3 results but cut the upper end of its FY24 guidance, with medical reserves disappointing amid CMS funding cuts and unfavorable member mix.
Advanced Micro Devices (AMD) [-5.2%] dropped after Bloomberg reported that the US may restrict AI chip exports to certain countries.
Citigroup (C) [-5.1%] beat Q3 earnings expectations but guided slightly lower on net interest income, with the CEO highlighting cost cuts and strong performance in the Wealth business.
Market Update
Trivia Answers
B) A beta of 1.5 is generally considered more volatile than the market.
C) Using borrowed capital for investment is financial leverage.
D) Amortization is the process of gradually writing off the initial cost of an asset.
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