Hello friends. I hope this post finds you doing really well. Summer is quickly approaching here in the deep south. Temperatures around our town are already hitting the 90+ degree level. It’s “hot” today — and humid!

The stock market surely isn’t hot at this time. As you know, it’s in a tailspin. Many stock market pundits have that “deer in the headlights” look about them as they scramble to forward their opinions as to “what’s next for the stock market,” or “where’s the bottom,” etc.

All the conversation on the economic front as well as the financial markets is centered on inflation. Indeed current inflation readings are staggeringly high and it’s apparent the Fed is growing concerned as it has ramped up the talk of multiple 50 basis point interest rate increases this year. Some believe we will possibly see a 75 basis point move next time as the Fed attempts to tackle inflation — but somehow to get it under control without sending the economy into a protracted recession.

In an economic climate like this one, people are fleeing presently from stocks. Anyone who follows the market can provide a long list of big names that in a period of several months have seen jaw-dropping price drops. A CNN Business article this afternoon states that more than 7 trillion dollars has been wiped out of the stock market this year thus far.

Of course, high growth tech stocks are getting pummeled the hardest as these companies are driven by fast earnings growth. The NASDAQ closed at 16,212 on November 22, 2021 and closed at 11,371 today. That’s a 30 percent decline in less than 6 months. Some companies like Zoom Video Communications, Inc. (symbol ZM) benefited from COVID and its share price peaked last summer. ZM hit $406 last July and closed at about 85 today, a bit off its 52 week low set earlier today (May 12) at a few pennies over 79/share. Netflix (symbol NFLX) is another example of a COVID benefactor that soared to 700 on November 17, 2021 as NASDAQ was about to peak and NFLX closed today at 174, off its very recent low of about 163.

My book, “Choose Stocks Wisely” states the well-established empirical fact that earnings drive stock prices. My premise of the primacy of the balance sheet to proper risk analysis addresses the matter of when earnings start to slow and disappoint relative to projected expectations, what is the potential downside? Only the balance sheet can help answer that question. How much equity support exists can only be determined by the financial statement that gives the amount and composition (assets and liabilities) of stockholders’ equity.

Putting all the emphasis on earnings and earnings growth when you buy a stock is what my book preaches against. It can seem to work well so long as earnings are going ever higher — and we’ve seen years of that. But failing to keep a close eye on what’s happening to the balance sheet relative to the current stock price can result in a stock portfolio getting decimated in nothing flat when earnings growth slows or, much worse, if it shifts to reverse.

Buying value based primarily on the quality and amount of balance sheet equity when the outlook for the business is favorable increases greatly the prospects of gain. Outlook is important because, again, earnings drive stock prices. However, buying value means the balance sheet equity support isn’t a mile below your purchase price when you buy. It’s “close by” — close enough to give you some good floor support to help you minimize potential loss if outlook doesn’t work out — like what we’re witnessing with many company outlooks now.

With this crashing market, there’s a lot of value that is surfacing and may become deeper value yet. “Low” takes on its fullest meaning after a very pronounced decline/crash in which the good are taken down with the bad. This doesn’t happen when economic and market sentiment factors are favorable. It happens when economic uncertainties bring about a recalibration of equity prices largely across the board. Finding the best values among the carnage requires proper analysis of the balance sheet.

While we never know where the “bottom” is, we can define “low” reasonably well if we utilize the very valuable “balance sheet.”

See you next time.

Paul