- The Secret to Being a Loudmouth
- How to Predict the S&P 500
- The Hard Truth Behind P/E Ratios
- “Never Played the Fool, Just Made the Rule”
I’m sure plenty of people would say that I’m something of a loudmouth. I have strong opinions, and I’m usually not afraid to voice them in no uncertain terms.
If I like a stock, I don’t mess around and offer up half-hearted endorsements like “maybe this would be a good one to own” or “this stock looks like it could be a winner.”
Like with Aehr Systems (NASDAQ: AEHR). On September 30, I said to buy it at $14 in my special report titled 3 Must-Own Tech Stocks for 2023.
I told you to buy shares of Aehr Systems again on November 7 after the company blew out earnings and jumped better than 20% the next day. Many analyst types get scared when a stock jumps that much in one day. It seems risky. So they’ll equivocate and say, “maybe you should wait for a pullback…”
But I’ve been around a long time. I know what a breakout looks like, I recognize when a company reports news or earnings that are clearly a game changer. Those stocks don’t pull back much if they do at all. If the share price is up 20% in a day, it doesn't matter – that stock is going higher.
On October 17, I recommended a call option trade on Aehr Systems. The very next day, I advised taking the 240% gain from that trade.
Loud. Mouth. Strikes. Again.
The Secret to Being a Loudmouth
The thing about being a loudmouth is you have to be judicious. You have to pick your battles. If you spout off any time you feel like it, and about any ol’ topic that strikes your fancy, that’s called being a blowhard. And nobody likes blowhards.
Being a good loudmouth takes planning. There’s preparation involved…
For example, I find it relatively easy to recognize when a stock should be owned. Because specific criteria become obvious once you see them a few times, generally, it’s some event that will cause analysts to raise their revenue and earnings estimates.
(Editor’s Note: It usually takes a week or two for analysts to officially adjust their projections after a game-changing event. That’s the loudmouth sweet spot.)
The loudmouth secret works because I also know that I’m not the only one looking for these criteria. There are hedge funds, mutual funds, pension funds, and scores of individual investors – all looking for the same thing. Find a stock showing signs of transformation, like Aehr Systems, and you can be pretty sure that other investors will put some wind in your sails.
Except for most hedge funds, mutual funds and pension funds don’t want to be loudmouths. At least not right away…
They want to keep a stock that’s transforming to themselves, so they can buy as much of it as they can before they go on Bloomberg or CNBC and proclaim what a great stock they’ve got to tell you about.
Yeah, Wall Street types play kind of a dirty game.
How to Predict the S&P 500
I find interesting the number of analysts, strategists, and investment banks that love to be loudmouths about market direction. Statements like “oh, the S&P 500 will end the year at 4,200” or “we expect the S&P 500 to retest its June lows at 3,200…”
I say it’s interesting because getting market direction right is much harder than projecting the trajectory of a company whose business is booming. And when it comes to predicting where the S&P 500 will be six months down the road or even three months, it is truly a crapshoot because the number of variables that must be accounted for is virtually unlimited.
The basic formula for an S&P 500 target is pretty simple. You take the total earnings-per-share for all 500 companies in the index, which you can find right here.
In 2021, it was $197.87 per share. Then you find a reasonable price-to-earnings (P/E) number for the S&P 500, multiply the earnings per share by that number, and voila! You have an index level.
On January 1, 2022, the p/e ratio for the S&P 500 was 23. So…let’s see….earnings per share $197.87…(mutter, mutter)… times 23….(thinking, thinking)…..(carry the one)….is 4,551. The S&P 500 hit a low of 4,582 on January 10, 2022. So, pretty much in the ballpark.
Now, a couple of observations…
The Hard Truth Behind P/E Ratios
One, earnings per share is a hard number. Companies report what they report, and that’s that. Add up the earnings for four quarters and you get the number. Two, price-to-earnings ratios are never a hard number, as the P/E ratio changes every time a stock price changes. A P/E ratio is purely subjective, it measures what investors are willing to pay for a company’s earnings.
(Editor's Note: I find it helpful to think of a P/E ratio in terms of a buyout price. If you got a loan to buy a company, how long would it take you to pay off the loan out of the company’s earnings? With a P/E of 10, it would take 10 years to pay off the loan.)
A P/E ratio is often said to be a sentiment indicator. Because they change with the investor's mood, in good times, investors usually feel like the good times will last forever, and so they will figure that the corporate will improve and maybe they can pay off that 10-year loan to buy a company in 8 years. Or, they figure they can even stretch it to a 12-year loan on the expectation that they will pay it off in 10…
That’s why P/E ratios for stocks go higher in bull markets. The risk feels low, opportunity feels high. Like in 2020, when stocks ran like scalded dogs after the COVID crash, The S&P 500 finished that year with a P/E of 35, which is high by any measure. Conversely, coming out of the financial crisis, investors remained very skeptical even as earnings recovered. The S&P 500 P/E ratio at the end of 2010 was 16, and at the end of 2011, it was 15.
When the P/E for the S&P 500 is low, like 15 or 16, it’s very easy to forecast target levels for the S&P 500 because it is very easy to see that the economy is improving, and investors will eventually get excited about it. And at the end of 2021, it was fairly easy to see that the P/E ratio had nowhere to go but down, even if the earnings per share part of the equation remained constant or even went higher.
Right now, the P/E ratio for the S&P 500 is approximately 21: just a little higher than the historical average. Assuming that earnings per share remain constant over the next year (which they won’t: analysts are currently factoring in ~8-10% earnings growth for the S&P 500), how do we assess whether investors will be bullish on stocks and send P/E ratios and stock prices higher?
Or whether more pessimism will emerge and investors will respond by sending P/E ratios and stock prices lower?
It’s an especially complicated question right now. Inflation has moderated a little, but does that mean the Fed is done hiking rates? China’s zero-COVID policy is relaxing, but does that mean demand from that economy will bounce back? Gas prices have come down, but Saudi Arabia can send them soaring anytime they want. And how would you quantify Europe’s economy and the war in Ukraine?
I don’t know. And I don’t think anyone else knows either. And that’s my point: with so much uncertainty, why would anyone take on the fool’s errand of putting out targets for the S&P 500?
“Never Played the Fool, Just Made the Rule” – Public Enemy
So if you’ve been playing along at home, you might remember this chart:
I posted this chart on Monday. And I said I didn’t think the S&P 500 would move above that green line (at 2,054) between Monday and the end of this year.
A famous investor named Bernard Baruch once said, “the main purpose of the stock market is to make fools of as many men as possible.”
Amen to that, because two days after I etched my little prediction into the annals of history, the S&P 500 busted over my green line in the sand…
I actually thought that chart was going to look a lot worse. And I was ready to eat crow, or my hat, or whatever the appropriate humble action was required. But…
I changed my mind. A little.
It is usually true that the market overshoots. Stocks get too expensive at market tops and too cheap at market lows. And an index like the S&P 500 will often breach a support or resistance level before reversing. This is the nature of a human construct like the stock market.
And so I do not concede that the market has made a fool of me and my little green line just yet…
But I will concede that the mood of investors is more positive than I expected. And that could well mean that stocks trade with a bit of a bullish bias for the rest of this month. A couple of weeks ago, I advised you to look out for reversals and not chase any strong intra-day moves higher. Today, I’m reversing that. Look for reversals higher from intra-day declines.
I still don’t expect a significant “Santa Claus” rally higher, but the next time I see my two favorite trading stocks – Aehr Systems (NASDAQ: AEHR) and/or StoneCo (NASDAQ: STNE) get whacked during the day, I’m buying call options.
And I’ll tell you something else: I’m on the verge of adding Meta (NASDAQ: META) to my “favorite trading stocks” list. I’ll dig into that a little more next week.
Until then, have a great weekend, and I’ll talk to you on Monday.
The Profit Sector