Wealth Accumulated

By D J Thomas, a large-cap stock market value investor and financial writer

Earnings per share

Why Adidas is a relatively unpopular large company

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An adidas trainer, black and white

Adidas reeling from Kanye colab

“The numbers speak for themselves. We are currently not performing the way we should,” CEO Bjørn Gulden said in a press release this week that also alluded to its inability to sell its Yeezy inventory with a potential impact of $1.3 billion. Last October the firm severed ties with Yeezy’s founder Kanye West after his well-publicised antisemitic tirades. In July 2021, shares traded at EUR319, today they’re at EUR139, with a dividend yield of 2.37%, and a PE ratio of 19. Adidas has all the hallmarks of a relatively unpopular large company.

Rinse and repeat

As if we didn’t get it first time around last week when the fed increased interest rates by 25 basis points, Fed chair Jerome Powell at the Economic Club of Washington said “the disinflationary process, the process of getting inflation down, has begun and it’s begun in the goods sector, which is about a quarter of our economy,”. Of the labor market, Powell ‘didn’t expect it to be this strong’ after a 517,000 print for jobs added in January. Those damned workers are just fouling the recovery. “My guess is it will take certainly into not just this year, but next year to get down close to 2%.” That’s a bet I’m willing to take.

Record profits at BP

Like ExxonMobil and Shell last week, the energy sector continues to reap the benefits of lockdowns and Putin’s invasion of Ukraine creating massive demand for oil with BP announcing record profits that more than doubled to $27.7bn (£23bn) in 2022. In the fourth quarter of 2021, Chief executive Bernard Looney said: ‘When the market is strong, when oil prices are strong and when gas prices are strong, this is literally a cash machine.’

A high dividend yield at Barrett Developments

With a dividend yield of nearly 8%, property developer Barratt Developments released its half-year results this week and decided to cut its dividend. David Thomas, Chief Executive said ‘Whilst we have seen some early signs of improvement in current trading during January, we will need to see continued momentum over the coming months before we can be confident that these challenging trading conditions are easing’. Pre-tax profits, earnings, and revenue all increased versus the same period last year. Forward sales were reported as 10,854 homes v 15,736 last year and the firm pointed to the pressure first-time buyers are under, roadblocking a clear pathway to recovery in 2023. Barratt has a PER of 5.78 and a price to tangible book of 1.03.

Disney cuts 7000 from workforce, proxy fight is over

Activist investor Nelson Pelz bought Disney stock at $92 a share in November 2022 for $865 million, launched a proxy fight and now the stock is worth $118 a share – a paper profit of $154 million after his stake increased in value to $1.1 billion. Peltz called off the fight this week after the announcement of a cost-cutting plan to the tune of $5.5 billion and a headcount cull of 7000 employees. Disney announced quarterly earnings per share of 99 cents, beating expectations, and revenue and subscriber numbers that came in as expected. Bob Iger said that “We believe the work we are doing to reshape our company around creativity, while reducing expenses, will lead to sustained growth and profitability for our streaming business, better position us to weather future disruption and global economic challenges, and deliver value for our shareholders”.

Bellway’s strengthening balance sheet

Like Barratt Developments, Bellway’s forward sales have declined and its customers are struggling with increased pressure from higher mortgage rates. Like all good housebuilders, it has large cash reserves and expects revenue to increase throughout 2023 despite the economic backdrop. ‘As the near-term economic outlook remains uncertain, we continue to take actions to maintain the Group’s balance sheet resilience. The measures include a freeze on new recruitment, limiting land approvals and a highly disciplined approach to production expenditure, as we align investment in work-in-progress to sales demand.’ When interest rates decline, you’ll find that demand for their homes will start to increase. In this climate, its easier for housebuilders to build their balance sheets rather than homes.

UK avoids recession

GDP fell 0.5% in December but that was not enough to impact growth for the final three months of 2022, coming in at 0% growth for the quarter. Last week The Bank of England said that it still expects a recession for the UK in 2023, but at a reduced severity than their previous forecast. The Office for National Statistics said that there were falls in services, education, and transport. Britain is scraping along the bottom quite nicely thank you.

How earnings from oil smash records whilst tech disappoints

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ExxonMobil gushes $56 billion in profits

It’s a record yearly profit for the company which previously stood at $45.2 billion in 2008. That was when oil hit $142 a barrel. The EU pre-empted Exxon’s swag with a $1.3 billion windfall tax in the fourth quarter. Shares finished the week at £112 also an all-time high for the firm. As noted two weeks ago, Putin’s invasion of Ukraine will prompt eye-watering earnings from the energy sector. Exxon’s Chief Financial Officer Kathryn Mikells said ‘strong markets, strong throughput, strong production, and really good cost control’ helped the firm to its record earnings.

Google earnings drop in Q4

Alphabet’s earnings came in at $1.05 per share, revenue came in at $76.05 billion continuing a downtrend trend in quarterly revenue growth since Q2 of 2021. In November 2021, shares reached an all-time high of $148 and have since fallen 29% to $105. The company also warned of a $2.3 billion charge it will sustain in Q1 of 2023 related to the 12,000 employees it fired in January. Further charges related to real estate – specifically its reduced office space, will start at $500 million in Q1 and further real-state charges are likely moving forward. Headcount growth cost it an extra 10% in operating expenses but CEO Sundar Pichai reiterated its focus on AI. With Google’s current legal proceedings in the US, there’s a lot for the executive team to be working on and shareholders to be mindful of.

Apple earnings growth slides

CEO Tim Cook blamed the macroeconomic environment and the lockdowns in China for not producing enough iPhones and iPads to sell for the latest quarterly earnings decline. Apple posted EPS of $1.88, down 10.9% YOY, revenue was down 5.49% YOY. Apple’s quarterly earnings have been declining in growth since the beginning of 2021, albeit from lofty heights (54.1% in Q1). The firm said that production levels of the iPad and iPhone are back to ‘acceptable levels’. The number of Apple active devices increased from 1.8 billion to 2 billion, including first-time buyers of the Apple Watch. Cook mentioned costs are being cut and hiring has slowed but did not see a need to slash headcount like others in the tech space. Despite the negative decline in earnings growth, Apple has faired much better than its tech peers due to prudent management of its hiring process, innovative product expansion (Apple Pay, Card, Music), and bringing new customers on board its product range despite the macro headwinds of the last few years: resilience.

Amazon issues guidance for Q1

Amazon expects YOY growth of revenue of between 4% – 8%, and online store sales declined 2% YOY. Consumers are slowly switching from e-commerce to high-street shopping since the end of the pandemic. CEO Andy Jassy, on top of announcing an 18,000 headcount cull last month, has frozen hiring, halted warehouse build, and is ‘… working really hard to streamline our costs and trying to do so at the same time that we don’t give up on the long-term strategic investments that we believe can meaningfully change broad customer experiences and change Amazon over the long term’. Amazon Web Services – its cloud business – declined in growth for the fourth quarter from 27.5% in the third, to 20%. Amazon earned 3 cents per share and operating income declined YOY due to $2.7 billion of charges, some of which related to severance payments. Shares are trading at $103, down from $183 in November 2021.

Meta shares explode 23% after results

Meta shares rocketed 23% in after-hours trading when the firm announced a $40 billion stock buyback, and beating revenue expectations for the fourth quarter. CEO Mark Zuckerberg said Meta’s “management theme for 2023 is the year of efficiency and we’re focused on becoming a stronger and more nimble organization.” Meta announced 11,000 layoffs last November. There’s also less expenditure expected in the future due to a switch to more cost-effective data centres. The Reality Labs unit responsible for the development of the Metaverse is expected to increase operating losses in 2023 ‘significantly’. Shares are currently trading at $186, down from $378 in September 2021. Without the share buyback, the value of Meta is in decline due to weak advertising demand and Tik Tok dominating ad revenue growth. Meta’s ad revenue declined 4% in the quarter and continues to be ‘impacted by the uncertain and volatile macroeconomic landscape’ according to Meta CFO Susan Li. Ad revenue represented 97% of Meta’s total revenue in the quarter.

Shell’s 115-year profit record

$39.9bn (£32.2bn) in 2022, the highest in its 115-year history. The price of Brent crude oil went to almost $128 a barrel after Putin’s invasion of Ukraine last year. It’s currently trading at $83. Shell said was due to pay $134m in a UK windfall tax for 2022 and more than $500m in 2023. Shell had paid $13bn in taxes globally in 2022 and only derives around 5% of its revenue from the UK.

US raises interest rates by 0.25%

The market expected it and The Fed delivered. A rise of 25 basis points from Jerome Powell and his team this week, the highest since October 2007. Inflation is still at its highest levels since the 1980s. Powell noted that inflation “has eased somewhat but remains elevated… inflation data received over the past three months show a welcome reduction in the monthly pace of increases… while recent developments are encouraging, we will need substantially more evidence to be confident that inflation is on a sustained downward path.”

UK interest rates highest for 14 years

The Bank of England raised interest rates by 0.5% to 4%. The market is expecting rates to peak at 4.5% in the summer before heading back down. The Bank has a 2% inflation target but prices are rising at 10.5%, a 40-year high. The market believes inflation reached its peak in the UK last October at 11.1%. Both the Bank of England and The Fed are in lockstep both with inflation and rate rises, but not on the upcoming recession – the IMF stated this week that the UK will be the only major economy to shrink in 2023, forecasted to be -0.6%.

How to use the price-to-earnings ratio to value large-cap stocks

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Man at a desk with phone in hand working on price-to-earnings

If you’re struggling with profitable investing in large-cap stocks, use the price-to-earnings ratio to value large caps to streamline how you actually look for stocks worth investing in.

I’m not forcing you to have a research process, but if you understand what an investment strategy can bring to your investing success, then stick around.

But a word of caution.

The price-to-earnings ratio (PER) is not the holy grail by any stretch, but it certainly makes the job of determining a sense of value for large caps much easier.

And that makes me feel good.

For context, I pursue a large-cap value investing strategy that involves determining what the real-world value of businesses are (intrinsic value) instead of the make-believe values assigned to them by the stock market and its army of commentators.

Pause.

Translation: massive companies like Apple, Microsoft, and ExxonMobil.

Yeah, I buy those.

But only when they’re on sale.

They call it purchasing shares in a business only when they are selling at a discount to its intrinsic value (margin of safety).

I call it a common sense approach to investing.

Wouldn’t you rather determine the actual, real-world value of a business instead of taking tips from an online forum or a talking head from the mainstream media?

The price-to-earnings ratio helps you to get an understanding of the intrinsic (real-world) value of a business AND whether it has a margin of safety (it’s on sale).

Perfect right?

Here’s the best way you can use the price-to-earnings ratio to value large-cap stocks.

How to calculate the price-to-earnings ratio

Before we get to the meat and potatoes, here’s what the PER actually is:

PER = share price, divided by the last reported earnings per share.

The price-to-earnings ratio is a way of appraising the value of a company based on its ability to turn a profit.

Earnings is simply another word for what accountants call net profit, commonly referred to as ‘the bottom line’.

Net profit is all the money a business has made minus the expenses of doing business like rent, taxes, payroll, and insurance.

Earnings per share is the amount of net profit a business has made divided by the number of shares a business has issued to the stock market.

Phew!

Stay with me here because the bottom is that there is no point in you buying stock in a business that does not know how to make a profit.

Yes, there is a slight learning curve to the PER, but if you want back yourself to learn a profitable investing strategy – and you really should back yourself – then you’re already one step closer to successful investing outcomes.

How to value Apple using the price-to-earnings ratio

Apple’s share price as of this post is $148.11 per share:

Macrotrends notes that Apple’s earnings per share over the previous trailing twelve months (earnings from the previous four quarters combined) is $6.11.

One year’s worth of a business’ earnings seems like a pretty good yardstick, right?

Apple’s share price (148.11) divided by its earnings per share (6.11) = a price-to-earnings ratio of (24.24).

Still with me?

Here’s a word of caution.

The pitfalls of the PER and how to deal with them

Many investors despise the price-to-earnings ratio (PER) as a measure of value.

They’ll say things like ‘managements manipulate earnings with accounting gimmicky to make earnings look better than they actually are’.

And they are absolutely correct.

It IS the case that accountants can and do manipulate earnings to make their business look as though it makes more money than it actually does in real life.

Everyone’s a hustler these days.

Also, some businesses are cyclical; their earnings may be extremely low or negative in one year.

In other years earnings may be extremely high.

Cyclical businesses sell ‘non-essential’ goods and services such as Walt Disney (DIS).

Although in my household, a Disney subscription has been essential since 2020.

Here’s an earnings breakdown for Walt Disney from Macrotrends that shows how earnings per share (EPS) can be ‘cyclical’:

10 years of Walt Disney’s annual earnings

Earnings consistency (or lack of) like this makes it difficult to value a company based purely on its earnings from one year to the next.

You’re much better off getting hold of a chart of the historical PER. It will help you to visualise past earnings value and compare it to where a stock is trading today (see below).

The Macrotrends website has historical for Apple as it does for hundreds of stocks.

Its screener is pretty awesome as well.

REVELATION: I hardly ever purchase a large-cap stock more than 20 times earnings.

The higher the price you pay for a stock based on its earnings, the higher the likelihood the stock will collapse in price after you’ve purchased it.

It’s the (value investing) law.

Combining the use of charts with the price-to-earnings ratio

A PER chart will show you where a stock has traded in the past based on its earnings so you can get a sense of where ‘value zones’ are.

Here’s Apple’s PE ratio chart from Finance Charts:

From 4th November 2008 to 25th November 2022

Working from right to left you can easily determine where the PE ratio is (24).

Then as you scan toward the left, you should begin to see that significant troughs at just above 10 times earnings have been the ‘deep value zone’ for Apple over the previous 14 years.

These deep value zones are where Apple stock sold at its cheapest.

Where they had the widest margin of safety between low price to earnings versus its real-world value.

More generally, you can easily determine that a PE ratio significantly below 20 for Apple has been a great place to buy its stock.

So as of the date of this post, Apple stock is too expensive to purchase based on a value investing perspective.

Implementing a value investing strategy with the PER

Just because a share price is too expensive for you to buy at today’s price, doesn’t mean it won’t be at some point in the future.

And this is the very heart of what is means to be a successful value investor: patience.

You can have all the discounted cash flow models and 13F filing reports you want, but without the patience to see a value-based strategy through, it simply will not work out to be a profitable strategy.

You’ll need:

  • patience to wait for the right price
  • patience to do your due diligence on each stock before the purchase
  • patience for the share price to rise in value when bought at a margin of safety, and
  • patience with yourself when, even after conducting extensive research on a business, its share price declines

That’s a lot of patience.

Free-to-use websites like Finviz are a great place to start because they have screeners that quickly list the stocks you want.

the Wealth Accumulated newsletter does the work for you by including updates on large-cap stocks.

Warren Buffett famously said:

If you aren’t thinking about owning a stock for 10 years, don’t even think about owning it for 10 minutes.

Warren Buffett

THAT’S HOW LONG-TERM THE VALUE APPROACH IS.

Thanks for making it to the end.

If you’d like to master the art of large-cap value investing to drive investing results, sign up for the free newsletter and get notified of when the next online course opens.