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Some Valuations are Now Reasonable
The S&P500 is not insane anymore. Certainly not cheap, but valuations are reasonable, even with higher rates:
Of course, valuations can get a lot lower in a recession. A LOT LOWER. Basically 4X EV/EBITDA is the lower bound for any public company. That's a scary statement because a lot of companies have Debt/EBITDA of 2.5X and if EBITDA were to shrink in a recession, the lower bound for a lot of stocks is zero. In the latter stages of the bull market, companies were trading at 12X EBITDA, but 8X is more normal. Forget revenue multiples, unless of course you are a short seller.
CSCO reported a decent quarter but the stock sold off due to supply chain problems. Its noteworthy that Cisco's demand situation is strong. Normally supply chain problems are temporary, but we are still hearing about supply chain issues all over. CSCO is a $180 billion equity cap that has consistently generated $15 billion in Free Cash Flow. Certain stocks like this are now becoming worth buying. At $41.50, CSCO looks quite reasonable on the long side.
Tesla got kicked out of an ESG index. Our take is that the "impossible" keeps happening.....
Retail is under pressure, but certain discounters are doing well, so the news is mixed. BJ's is trading up 10% after a blowout quarter, and yesterday's TJX news was also quite positive. DECK is trading down big today, but the drop from over $400 to $217 has removed the overvaluation from a solidly profitable firm with a good balance sheet. Two weeks ago, things still looked overvalued across the board. At these levels, 20% of the companies are now reasonably valued. Don't get us wrong, nothing is on sale yet, but valuations are reasonable. DECK is a good example: analysts seem confused whether DECK will earn $15 or $11, but either way, at $217 its a lot cheaper than $420 from six months ago.
Homebuilders look extremely cheap at these levels. TOL $47 and earning $10 or $11, and its not cyclical, its growing. PHM is same story, just a bit cheaper: $43 earning $10 or $11. LEN is $74 and earning a non-cyclical $17. Homebuilders used to be cyclical, but not so much anymore. These stocks are easily going to trade up to 8X earnings when the Fed stops fighting inflation.
There are going to be a lot of doubles from today's levels. HLF is a bit of a dicey company, but it has thrown off $300 million in free cash for years and its trading at a $2.3 billion equity market value. A cash flow story that justified a 2021 price consistently above $45 is now available for $21.
GS is a storied franchise that looks like they easily earn $40 and could surprise at anytime and earn $70. At $307, GS is another stock that looks reasonably valued.
FL earns $4 and is trading at $30. This environment has not been good for high priced retailers like FootLocker but under different circumstances FL can earn $8, which implies the stock has downside to $20 but upside to $120 if you can wait 4 years.
Unfortunately the indices are dominated by large cap tech names, many of which are ambiguous. Nobody really knows whether FB earns $10 or $15, which is why the stock is hovering around $200. Amazons earnings have always been opaque, and its difficult to know how much of their capex and R&D is growth and how much is maintenance. TSLA's numbers are extremely volatile, as deliveries are all over the place, and its unclear how much earnings power autonomous driving would produce ( and when autonomous driving would be fully legal ). These opaque mega-caps are much more reasonable now and won't be weighing on the market indices much longer. MSFT at $255 is a lot less risky than at $320.
The market tried to rally and could not hold $3900 - look for a retest of $3850 today. For trades, follow the technicals and be very short term both with risk control and profit taking. For investing, look at 3 and 5 year earnings - there are plenty of good stocks that will be fine over the next three to five years.
The time for fear has mostly passed. We should have been more fearful during the perfect storm 6 months ago: (a) Fed announcing tightening, (b) Russian troop buildup on the border and (c) higher inflation, combined with (d) absolutely insane valuations in stocks, bonds and real estate. Now a lot of the bad news is behind us although we are not seeing much good news yet. We may have to go through a short recession but the recession may not be as bad as war, a hawkish fed and stupid valuations. We are getting closer to the time for opportunism.