One of the older academic ways of looking at stocks is the dividend discount model, which starts with the extreme simplification that stocks are a funny kind of bond. This implies that we can determine what a stock is worth by figuring out as best we can what a company will earn in every future period, calculating the present value of each and summing the results.
This works very well in the bond world, where the holder gets periodic pre-determined interest payments + return of principal at the end of the borrowing’s life. Not so great with stocks, as the craziness of the Nifty Fifty era in the early 1970s showed. If we assume, as people did back then, that corporations have close to infinite life, then the present value of even pathetic future earnings becomes a gigantic number.
One thing this approach gets right, though, is that it’s reasonable to think of the value of a stock as its asset value today plus the sum of the yearly amounts we think the company can add to that in the future.
Say a company will grow for the next ten years before starting to fade away. Also let’s say the pandemic wipes out 2020 earnings completely and half the potential growth for 2021–numbers I’ve plucked out of the air …but you have to start somewhere. How much less is the company worth in a pandemic-gripped world than we thought before?
A fast-growing company should be able to repair damage and resume expansion relatively quickly; a slow-growth firm will take longer; a senescent company may not survive.
To make up numbers, the fast grower may be worth 10% less than we thought pre-pandemic, the slow grower 25% less. Avoid the walking dead. And, of course, there are firms like Amazon whose near-term and long-term prospects are enhanced by the present difficulties.
After an initial panic (a typical market first step) that saw prices plunge by almost a third, the stock market has been at work, little by little, evaluating future prospects. In my experience, this is what the stock market does best.
I think we’ve reached a point where the market is looking at slow growers and thinking that their underperformance so far vs. fast growers has left them too cheap. So we’re likely in a phase where investors are picking through the rubble for hidden gems, finding the money to buy them by selling year-to-date winners.
The biggest complicating factor is one equity investors routinely try to avoid: politics. Put to the side Trump’s handling of the economy, which I regard as a disaster of epic proportions in the making. But this isn’t really visible yet. His catastrophic bungling of the coronavirus crisis, which has produced a worst-in-the-world outcome for the US, is. To deflect attention from this failure, he is trying to manufacture a bogus civil rights crisis in 1960s segregationist style.
Is there popular support for the Putin-esque world Trump appears bent on creating? If so, who would want to live in this country? As a citizen, my personal hope is that Trump has gone a step too far through his escalating attack on the integrity of the armed forces.
As an investor, my picture has been of an incompetent administration acting as Trump appears to to me have always done, ineptly but to the disadvantage of those who trust and support him.–and facing an equally inept political opposition determined mostly to defend its own party apparatus. Hence, my belief in gradual capital flight.
Maybe there will be a wider range of possible outcomes as Trump drifts further away from reality. For now though, the only clear idea I have is that economy-sensitives will play catchup for a while, at the expense of pandemic beneficiaries.