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.
May 2018