Fundamentals: An Antidote to Emotional Extremes

““The sillier the market’s behavior, the greater the opportunity for the business-like investor." 
— Ben Graham
 
 
Investors continued to bid up equities as COVID-19 infections plummeted, shutdown mandates were lifted, and consumers received another infusion of direct stimulus payments from the government. The speed and strength of the response to the winding down of the global pandemic was reflected in corporate financial results. In the most recent quarter, nearly 80% of companies in the S&P 500 Index reported better than expected sales, while more than 85% announced earnings that beat consensus Wall Street estimates.

The robust earnings season provided staying power to the ongoing surge in equities that began in 2020. Investors continued to take a risk-on approach that bordered on speculative excess in some instances. The re-emergence of so-called meme stocks highlighted investors’ willingness to ignore fundamentals in pursuit of overnight riches. 

Speculators looking for a quick buck weren’t alone in their optimism. Consensus Wall Street estimates for S&P 500 earnings growth, as shown below, clocked in at nearly 32%—the strongest reading in the past 35 years. Unfortunately for investors, historically robust growth expectations have been met with lackluster performance for the index in the following year.
 
As Good as it Gets?
Heartland Advisors Value Investing Total Market Cap to GDP Chart
Source: Refinitiv and Ned Davis Research, Monthly data from 12/31/1984 to 5/31/2021. Copyright 2021 Ned Davis Research, Inc. Further distribution prohibited without prior permission. All Rights Reserved. See NDR Disclaimer at www.ndr.com/copyright.html. All indices are unmanaged. It is not possible to invest directly in an index.
Past performance does not guarantee future results.

 
The ongoing march higher for equities has provided many investors with what we view as a false sense of security. After starting the year with an eye on fundamentals and valuations, buyers have cast aside concerns about price metrics and balance sheet strength as well as the potential for inflation to erode consumer demand going forward. 

Many areas of the market are trading at levels that leave little room for error. We believe a superior path to navigating the quarters ahead in a market that has become increasingly fragile requires a fundamental investment approach that incorporates valuations, financial strength and seeks to identify catalysts that can result in a change in perception by investors.

When analyzing opportunities, we look at the cost of owning the entire business—including all debt—relative to the profits generated by the company. Today, as has been the case for the past few years, our portfolios are materially underweight leverage because we view solid balance sheets as a way to potentially mitigate risk from unforeseen economic disruptions.  

Sincerely,
Your Heartland Team

 

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Past performance does not guarantee future results.

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