When investing it’s important to remember that two things impact the value of an investment – the amount that it is earning and how much people are willing to pay for it.
When considering the stock market – the Earnings per Share (EPS) are easily understood and reported. The multiple or what people are willing to pay is influenced by so much.
It’s this change in multiple that has the greatest short term impact on the price of a stock. Investor confidence, belief in the company, macro effects (like trade wars or tariffs) are some of the variables at play.
The recent market selloff in Dec and January have definitely been influenced by theses two variables. Companies are beginning to see a slow down in their earnings and investors willingness to pay for these earnings is declining hence creating the recent volatility.
I am of the opinion that high frequency trading and algorithmic trading is exacerbating the moves in the market. It makes the moves up sharper and moves down gravity like. The old adage of “market climb up stairs and go down elevators” has never been more poignant.
Investors must now decide how much they are willing to pay for the earnings of companies whose earning may be in decline. Should you be paying a record high multiple for an asset with declining earnings power?
We will find out.