David Lentz

Earnings Power vs. Investor Sentiment

Nice article, sparking substantial discussion.

The fly in the ointment, as pointed out, is the fallibility of the "consensus estimates" of future EPS values. If they were at all reliable, stocks would never stray from those lines.

But in truth, they're ALMOST ALWAYS low when earnings are doing well, due to the intersection of the tendency of companies to lowball guidance, and the tendency of analysts to lowball estimates (it's much better for an analyst to make estimates a little under actual reported earnings than to err on the other side), and they're ALMOST ALWAYS high when earnings sag, as the causes for sagging earnings are normally not predictable and tend to arrive as a surprise.

Picking localized highs/lows to sell/buy at turns out to be usually no better than throwing darts. I find that if I track PE vs time for any given stock, one can see when it is historically on the high side, and also when it approaches the lower range of historical PE fluctuation. It can hug the upper/lower end of the range for quite a while, but usually in bubbles or recessions, there is often a distinct spike that makes a reasonable point at which to buy/sell with a bit lower risk over a reasonable time period (1-3 years) that the decision will work out.

If you're a day trader, with short time horizons, then none of this matter to you, as your universe is a matter of hours/minutes, not weeks/months/years.

That's about as reliable a thing as I can find.

Looking forward, the possibility of a significant recession with rising unemployment might make for a buying opportunity in AAPL, with it declining to something around 130 as the water goes out of the stock PE pool, and all the boats go lower, NO MATTER WHAT THEIR EARNINGS ARE DOING.

But even if you bought it on New Year's Eve for about 200, you would likely be profitable within a year, and making respectable profits in a couple of years.

Of course, if you bought in near 130 at the bottom of this hypothetical recessionary blood-letting, ... well, in that event you should send me some money to celebrate on 12/31/2008. Good Luck.