Speaking in the broadest terms, we can (and should) look at a an individual stock, an industry or the stock market as a whole from two perspectives:

–why am I buying this particular thing (the concept), and

–how much should I pay for it (valuation).

Concept may start out with something a simple as an elevator speech:  “Tesla is the leading maker of electric vehicles, which are displacing conventional fossil fuel-driven alternatives much more quickly than the consensus expects.” or “Intel has stagnated for years, losing its cutting edge position as a semiconductor chipmaker. The company has valuable intellectual and manufacturing assets, however. As soon as irate investors install better management, it will return to its former glory.”

Valuation starts for many stocks with a glance at the PE ratio based both on trailing earnings and on consensus beliefs about what future earnings will be. For a potential turnaround, the first step is more likely a peak at the balance sheet and as guess at what the plant and equipment, plus any intangible assets. might be worth if they were being utilized efficiently.

The elevator speech is not an end point. TSLA is trading at 283x trailing earnings and 108x the consensus guess at 2022 results. Given that the forward PE on the S&P 500 is about 22x, TSLA seems expensive, assuming the consensus is correct. INTC, on the other hand, is trading at about 12x earnings, both trailing and forward, and yielding 2.6%. Arguably, we’re being paid to wait. Here the important question to pursue may be how long the wait is likely to be. If we had acted on the positive story at the start of 2018, we’d be up by about 10% vs. a gain of 50%+ for the S&P. Investors normally tend to find a combination of concept and valuation that works for them.

My take on the US stock market over the past 18 months or so is that this hasn’t happened. Virtually all the emphasis has been on concept, with next to none being paid to valuation. At a time when interest rates were zero-ish, with a high likelihood they would stay that way for as far ahead as investors were willing to think, this makes at least some sense. For what it’s worth, it’s also the way the Japanese market acted in the late 1980s, under similar interest rate circumstances (the only other case I’ve ever lived through).

What strikes me about the quarterly earnings reporting we’re in the midst of is that suddenly valuation seems to be back in play. Yes, MSFT (a stock I own) had a blowout quarter. But it’s already trading at a premium multiple of 35x this year’s earnings. And the analyst earnings estimate of 12% eps growth for 2022 better just be a placeholder–because it’s too close to the earnings gain the average stock is likely to put up to avoid contraction of its PE multiple toward the S&P’s (finance-speak for “the stock will go down a bunch”).

Six or nine months ago, MSFT would probably have gone up a few percent on this kind of good earnings news–maybe more. But yesterday, despite an initial blip up, the stock ended the day in the plus column by 0.1%. Yes, that’s a better outcome than many other recently reporting companies have achieved. But I still think it’s evidence of a sea change in investor thinking about stocks. It’s no longer about what companies will prosper as we’re fighting out way through the pandemic. As I see it, Wall Street is beginning to take a return to some form of normality for granted. Simply coming out the other side of the pandemic while still afloat is no longer enough. That’s already being assumed. What will separate winners from losers in today’s market is actual and anticipated earnings performance in the post-pandemic world.

To a considerable degree, PEs are determined by the price of substitutes, meaning the 10-year Treasury note. The prospect of rising interest rates will doubtless become an obstacle to be overcome by the stock market at some point in the future. Maybe there’s even a little bit of that worry in the way Wall Street is reacting to earnings reports. But not a whole lot, I think. This is a return to the normal Wall Street emphasis on tempering concept by considering valuation.

I don’t this necessarily means stocks in general will begin to trend down. It does mean, I think, that professional investors will be more cautious about bidding up a stock based mostly on an industry story or a macroeconomic trend, without satisfying themselves that there’s also solid profit growth in prospect.