Déjà vu
My discussions with a variety of market participants in the past couple of weeks indicate that we are at a stage in the market cycle when the investors and analysts begin to change their valuation arguments. Extrapolation of one-quarter performance to the next ten years, “story” pages of corporate presentations, political visions of growth, etc. begin to dominate the assumptions in the valuation matrices. Three to five years of forward earnings are being considered for arriving at twelve-month price targets. My experience of the past three and half decades suggests that this kind of deviation always leads to mispricing of stocks and eventual sharp corrections. It is important to remember that the return on the investment in publicly traded equities is a function of three factors: (a) earnings growth; (b) changes in price earnings (PE) ratio and (c) dividend. The earnings growth is a function of multiple factors, e.g., (a) capacity (production capability); (b) demand environment (market...