Price/Earnings Multiple Expansion
Of
the 32.4% increase, 18.4% (or 57% of the total increase) was due to an
expansion in the price/earnings multiple. Investors buy stock in anticipation
of a future earnings stream from the issuing company. The price to earnings
ratio represents “how many times” the company’s earnings that investors are willing
to pay for the stock. In 2013, that price/earnings multiple expanded from
approximately 14 times to over 16 times. Quantitative Easing (the Fed’s buying
of Treasuries and mortgage backed securities) figures prominently in this
increase; the Fed’s buying drove interest rates so low that stock became a more
viable investment (even with the increased risk).
Dividend Increase
Dividends
accounted for 2.8% of the 32.4% gain (9% of the total increase).
Earnings
Corporate
earnings accounted for 11.2% (or 34%) of the total 32.4% increase in 2013. What
about those earnings? How were they obtained? In many cases, earnings were driven by expense reduction, not increased
revenues. A company can do only a finite amount of expense reduction and
still remain in business.
What Does This Mean?
Given
the above, how likely are we to continue such growth? Ninety one percent of the
gain was driven by factors that may not be in play going forward. At Paragon Financial Advisors we believe that
the equity markets offer significant long term benefits; however, the ride from
“here to there” can be bumpy. Come
visit with us about ways to try to manage the risk in reaching your long term
financial goals. Paragon Financial Advisors is a fee-only registered investment advisory company located in College Station, Texas. We offer financial planning and investment management.
