Inflation Adjusted Stock Earnings

June 23, 2009

Editor's Note: Earnings are what fuel market gains... without them the market is just running on fumes.  To the right is a chart that shows S&P 500 earnings adjusted for inflation.

Over the last few months investors have turned from 2008's fearfulness to  fearlessly investing into an environment where earnings are virtually non-existent. 

This brings to mind a famous quote from none other than legendary investor Warren Buffett,  "Aim to be fearful when others are greedy, and greedy when others are fearful." 

So is this a time to be greedy or fearful?  I would vote for fearful.  But a time is coming when the tide will turn.  In this article by Andy Gordon you will see how three forward looking men put aside fear and went against the trend to make huge fortunes.

Keep your powder dry and wait for the opportunity to act when others are quaking in their boots. And Andy provides a good recipe for what to buy.

History Repeats Itself

By Andrew Gordon

Native Tennessean John Templeton saw Hitler’s army roll up one Central European country after another and then take aim at Western Europe. Companies left and right were falling into bankruptcy. Stocks were nose-diving, many going for under historic lows.

So what did John do at the height of this nightmarish freefall?

He was so sure that what he was doing couldn’t fail that in 1939 he borrowed $10,000 from his boss. He then carefully selected 104 stocks on the New York Stock Exchange to invest in.

By the time the war was over, 100 of the 104 stocks had zoomed up in the post-war market surge.

Templeton made a 500 percent profit in four years. He repaid his boss and had $40,000 left over.

By striking when the iron was hot, Templeton went on to become one of America’s most successful and rich investors.

And he wasn’t the only one...

At the same time that John was seeing his bets pay off, a WWII-bomber borrowed money from the Seagram’s family to buy a struggling charter airline for $60,000. The Air Force vet, by the name of Kirk Kerkorian, built the fleet on the cheap with surplus Air Force bombers which began carrying freight back and forth between America and Europe. The small nearly worthless charter airline grew as trade between America and Europe exploded.

Kerkorian eventually sold his company for $104 million and went on to become a billionaire – investing in everything from autos to gambling, including majority shares in MGM.

At the same time, high-school dropout David Murdoch was seeing the same historic opportunity in this rock-bottom market and borrowed $1,800 to buy a diner. He flipped it for a small gain and bought another property at a huge discount. He made a bigger gain. The gains kept getting bigger and bigger until David parlayed them into a $4.4 billion fortune.

Three men. Three fortunes. But what does this mean to you?

Let’s now fast-forward to the present. They don’t call this rally a “sucker’s rally” for nothing. It rose on fumes. It certainly didn’t rise on earnings. Take a look at the S&P’s earnings in the past 20 months. They’ve nosedived from $80 to $7 – the biggest drop ever recorded.

Market-Earnings Have Dropped Like a Rock

See Chart above right or click
Inflation Adjusted S&P 500 earnings to see the larger chart.

The S&P’ earnings performance in the 1940’s was bad. Today the S&P is doing even worse.

We saw a severe bear market in the 1940s and we’re seeing one today that is just as serious.

The same thing also happened in the 1920s. By 1921, the stock market had fallen by 45.6 percent. While many people were standing around wondering what to do with their money, some individuals were busy making a fortune off of the stock market.

The market climbed 495 percent over the next decade.
 

In the early 1940s – when Templeton, Kerkorian and Murdoch were taking advantage of ridiculous low-prices – the market climbed 170 percent over the next decade.

And like the 1920s and 1940s, stock prices will be dropping to irresistible bargain prices once again.

The two main takeaways here are that...

1. You should buy when assets are priced as if the world is about to end.
2. Our current “Great Recession” has given you a gift of a lifetime.

I’ve Waited 30 Years for This Moment

Finally, the opportunity to capture oversized profits is resurfacing again...

John Templeton bought into a few companies that washed out of the market. You should do it a little differently. The market has been beating up companies indiscriminatingly – the big with the small ... the strong with the weak.  You don’t have to buy small and risky stocks, not with some of the market’s biggest companies going for 40-50 cents on the dollar.

If these “best of the best” companies just go back up with the market, you’ll pocket over four times your investment in the next two years. But they should do much better than merely track the market.

This recession in not only a gift to us, it’s also a gift of a lifetime for these big “global industrial merchants” for these three reasons...

1. They can take advantage of the dollar’s weakness by selling their products overseas cheaper than usual.
2. They have the flexibility to pick and choose what markets to target from dozens of countries around the world. The world’s economies may have fallen in lockstep, but they’re rebounding at various rates. For example, Korea, Brazil, and China are showing a little more bounce in their step than many countries.
3. This is the biggest reason: These companies have turned into bullies.