Record setting profits and dull stocks—what gives?
Profits continue to rise but stock prices remain depressed. The chart below illustrates what we mean. This is just the technology sector of the S&P 500 and we can see that stock prices have gone nowhere for the group in five years. Earnings (profits) however have gone up over that stretch and are about to set a record once the current quarter is fully reported. (the dotted line shows estimates for the next couple of quarters)
Why aren’t investors paying up for these excellent results? Maybe because they are afraid that business leaders are milking their businesses rather than growing them.
What does that mean? Every business manager knows there are times when you take profits out and those times when you plow the cash back into the business to take it to the next level. It takes faith and guts to bet on growth and right now business leaders are just like the rest of us, worried and uncertain about what the future holds.
Investors may be sensing that the strong profits of today may represent a great harvesting of cash without the prospect of growth in future earning power.
Happily, there are businesses (and we own a few of them) that can produce profits, while at the same time, investing for the future. The profit margins in these businesses are very high and the need for capital is very low, which means they can have their cake and eat it too.
The technology sector has more than its fair share of these types of businesses and it is one reason our portfolios are heavily weighted with tech. The sector also sells half or more of its products all over the world, which we think is another advantage.
Our portfolios have moved into positive territory for the year, thanks to very good earnings reports and a recovery in stock prices since June. This could be the beginning of a major move up in prices, but a trading range seems more likely for the short-term. The election is a major source of uncertainty and until we get further into the fall, the market will not know how that will turn out.
No matter the result in November, investors will have a better idea of what to expect once it’s over and that could help prices.
Until then we will continue to fine tune the portfolios to benefit from a modestly growing economy.
Best regards,
Daniel A. Ogden
dogden@dockstreet.net
