Price vs. Earnings

May 2018 //
Investing
History

One year is too short a period for stock prices to closely track earnings growth, but as time wears on, history tells us the closest approxi­mation to stock price growth will be earnings growth. If you think about it, this makes perfect sense. If you own a business over a period of years and the business increases its earnings by X%, it would be reasonable to expect the value of your business to increase by something close to X%. However, this has not neces­sarily been the case for stock investors over the last 12 months and sometimes longer. The stocks of some companies—mostly large-capitalization “growth” companies—have appreciated significantly more than earnings have grown. …  Based on a clear reading of history and common sense, we don’t think stock price growth can significantly trail earnings growth indefinitely, especially with a starting point of relatively low P/Es. On one hand, it is frustrating to correctly estimate earnings growth without seeing commensurate stock price growth. …On the other hand, if the future is at all like the last 100+ years of stock market behavior, stock prices will track earnings closer than any other variable.