coronavirus: fooling around with numbers

Let’s assume that the negative effect of COVID-19 is that publicly-traded companies have not profits for full-year 2020.  I don’t mean no profit growth, I mean no profits at all.  Maybe the situation is worse than that but let’s look at this case first.

Assume company A is growing profits at 8% per year, and will continue to do so for the next decade.  Not a great performance.  Average-y  …but not nothing, either.   The present value of those future earnings is 12.5x what the market assumed this year’s earnings would be.  Excel out this year’s earnings and the PV becomes 11.5x.  That’s a drop of 8%.

Assume company B grows at 20%, a rate that only the elite can sustain over a ten year span.  The PV in this case is 22x.  The loss of this year’s earnings reduces the PV by 4.5%.

 

A second factor to consider–a crucial one for small business but not so much for firms large enough to be publicly owned–is getting to next year.  The main obstacle is leverage, either financial (generating enough cash to service debt) or operating (needing to run at close to full capacity to pay for expensive infrastructure (think: airlines, cruise ships, frackers, semiconductor fabs)).  The riskiest cases have both.

Let’s pluck numbers out of the air and say the “survival risk” group makes up 5% of the S&P 500 (too high!) and that their value goes to zero (too pessimistic; losing 50% is probably closer to worst case).  That’s a loss of 5% to the index value.

 

Adding the two together, we get -9.5% – -13%.

In other words, the coronavirus alone doesn’t justify anything near the extent of the stock market plunge.

 

Two other factors:

–maybe the S&P was toppy before the decline began;  after all, the index gained 30%+ last year, mostly on PE expansion, not earnings growth

–the chilling specter of the administration thwarting medical efforts to contain COVID-19 while spouting insane conspiracy theories.   To some degree the Trump effect (the market dropped by 10% after his bizarre speech the other night) is being countered by state and local authorities and private business taking matters into their own hands.

My conclusion?  Trump + trading bots gone wild will likely continue to cause ups and downs–probably more of the latter–for a while.  For us as individual investors, our main advantage in the stock market is taking a longer view than most.  This is especially true today, I think.  The thing I’m hanging my hat on is that the coronavirus will most likely play itself out as an investment issue with time.

 

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