July 2014

The Importance of Earnings

Especially since the Dow Jones Industrial Average has been flirting with and then finally topped the 17,000 mark, the doom-sayers have been out in force. Like Chicken Little in the well-known children's story, they are certain that the sky is falling on the market recovery.

Take, for example, this headline from the July 1, 2014 online edition of Forbes: "These 23 Charts Prove That Stocks Are Heading For a Devastating Crash."

Or this one, from moneynews.com on July 6: "Why the Stock Market Crash Will Happen Any Day Now."

These are not isolated examples. Nor are they new. For example, on October 30, 2013, the New York Post ran a headline that said, "The Markets Will Crash, the Question is 'When?'" On that day, the Dow closed at 15,618. Investors who were spooked out of the market by that headline missed out on more than 1,000 points of growth.

Certainly the market rise will not continue forever. It will moderate, and there will be downturns. But before assuming that those downturns will constitute a serious "crash," it is important to consider some facts.

First, this is the most robust recovery in history, and that understandably makes some people wonder whether it is a false or unsustainable recovery. But remember that the crash that preceded it was also historic. It was the worst economic downturn since the Great Depression; nothing else even came close. It was a global crisis. Without unprecedented intervention by the federal government, it probably would have caused the collapse of the entire U.S. economy -- or even the world economy.

The recovery began with fits and starts, but it has been pretty consistent over the last few years. And perhaps most importantly, it seems to be supported by continuing positive earnings growth. While it is true that the market is trading at a slightly higher P/E ratio this year than last, that ratio remains within a reasonable range. Currently, we are at the high end of valuations, which could be considered the bad news.

But the good news is that profits remain strong -- and overwhelmingly, analysts seem optimistic about strong earnings continuing. Corporations' financials are in extraordinarily good shape, and that is showing up in analysts' earnings estimates. Unlike in most years, analysts have not walked back those estimates much if at all after the first two quarters. And historically, stock prices rise largely on profits, profits and more profits. As long as companies keep making higher profits, their stocks should continue to do well over the longer term.

So does that mean you should go all in on the market? Not necessarily. At Peachtree Investment Partners, we believe you should find and follow an investment approach with which you feel comfortable and that accommodates both your long-term goals and your feelings about risk.

We also know that despite the importance of earnings numbers, there are a lot of things that could cause the market to react negatively, including geopolitical unrest, especially in the Mideast; problems in developing economies; and action -- or inaction -- by politicians in the United States and abroad.

We feel that the best long-term approach to investing in the market is to choose solid companies. We focus primarily on large U.S. corporations that have a strong track record, good management and a competitive advantage.

We also prefer stocks that pay a dividend. Dividends can help smooth out market volatility, and they also can add significantly to returns over time. In fact, since the end of 1929, dividends have represented about half of the market's total return.

In investing as in life, no one knows what the future holds. But as investors, we have to continue to make the best decisions we can to ensure a strong long-term financial future for ourselves and our loved ones.

Garry K. Schaefer
Atlanta, Georgia
July 16, 2014

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