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  1. Home
  2. / Investing
  3. / Stocks

Real Money Post Industrial Average Again Outperformed, but Watch Valuations

The Real Money Post Industrial Average is up nearly 11% so far this quarter, beating all major indices, but valuations are looking stretched.
By CHRIS VERSACE
Aug 13, 2020 | 10:00 AM EDT
Stocks quotes in this article: BKNG, AMZN, FB, PYPL, NFLX, SBUX, KHC, CMCSA, BIIB, AAPL, ADBE, QCOM

As we approach the halfway mark for the current quarter, the Real Money Post Industrial Average (RMPIA) is up just shy of 11%, putting it firmly ahead of all the major market indices so far this quarter, and extending its year-to-date lead over the S&P 500, Dow and small-cap heavy Russell 2000. One of the things that has been on my mind of late is the pronounced rebound in the market that has unfolded since its recent bottom in late March, which has led to near-record highs and arguably stretched market valuations. I say stretched market valuations because the S&P 500 is trading at 25.8x expected 2020 EPS of $131.02 and 20.4x expected 2021 EPS of $165.68. And I think that is where some of the problem lies.

While many are focused on the expected snap back in EPS growth in 2021, which looks to be about 26% year over year, the reality is that big growth rate is coming off of a pronounced EPS pullback in 2020 thanks to the pandemic. As we can see in the chart below, 2019 EPS for the S&P 500 was $163.02, which means two things. First, as we near the end of the June-quarter earnings season, 2020 EPS for the S&P 500 is slated to fall roughly 20% compared to 2019 and that drop into trough-like territory helps explain the extended P/E being assigned to the market these days.

Second, and far more concerning, is the expected EPS growth to be had over the 2019-2021 period for the S&P 500, which looks to be all of just 1.6%. Viewed against that backdrop, the current market multiple on 2021 expected EPS of 20.4x means investors are being asked to pay up for very little EPS growth.

As an investor, that's not a very attractive opportunity in my opinion, especially given the S&P 500 on average has peaked at 18.6x expected earnings over the 2001-2019 period.

Circling back with this in mind to the Real Money Post Industrial Average, we can better understand why this basket of stocks is leading the way vs. the major market indices. The why behind that performance is simple: the collective basket of RMPIA constituents is poised to grow its 2019-2021 EPS by 8.5%, which reflects an almost 29% increase in 2021 after the expected 16% drop this year compared to 2019.

That 2021 increase is led by meaningful double-digit EPS growth expected at Amazon (AMZN) , Facebook (FB) , PayPal (PYPL) , Netflix (NFLX) and others. Among the constituents, more-pronounced rebounds in 2021 EPS are expected at Booking Holdings (BKNG) and Starbucks (SBUX) , which, according to current consensus EPS forecasts, are slated to rise 260% and almost 103%, respectively, year over year in 2021.

Here's the thing. Even after that surge, Booking is still expected to see its 2019-2021 EPS fall by almost a third as pandemic-related questions and subsequent uncertainties surrounding the travel and leisure sector remain. And that isn't the only company that is expected to see EPS contract during that timeframe. Others include Express Scripts (ESRX), Kraft Heinz (KHC) , Comcast (CMCSA) , and Biogen (BIIB) . In full, seven RMPIA constituents are expected to see their EPS growth over the 2019-2021 period lag the expected 1.6% improvement in S&P 500 earnings over the same period.

In my opinion, a more -onstructive perspective for investors to walk away with is this: More than two-thirds of the RMPA constituents are expected to deliver faster EPS growth than the S&P 500 over the 2019-2021 period. And the stronger the EPS growth prospects among RMPIA constituents, like that expected for Apple (AAPL) , Adobe Systems (ADBE) , Facebook, Netflix (NFLX) , and Qualcomm (QCOM) , the greater their returns have been.

Two thoughts on the above. First, given the nature of how EPS is calculated, there can be some below the operating line happenings that we need to consider. For example, stock buyback activity that shrinks the outstanding share count and can make reported EPS look more attractive than it might really be. In my time, I've seen this on more than a few occasions and I've also seen a few where a company reports an EPS increase even though its Net Income fell, all thanks to its share buyback activity.

Second, EPS expectations are a snapshot in time, which means that investors need to revisit them on a periodic basis, updating expectations and asking questions along the way, especially if those revisions are to the downside.

(AAPL, SBUX, AMZN, and FB are holdings in Jim Cramer's Action Alerts PLUS member club. Want to be alerted before Jim Cramer buys or sells these stocks? Learn more now.)

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At the time of publication, Versace has no position in the securities mentioned.

TAGS: Fundamental Analysis | Indexes | Investing | Markets | Stocks | Trading | Real Money | U.S. Equity

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