Hi YXI friends,

The market begins to fall into a consolidation pattern. It is a good opportunity to examine the valuation side of the individual equities alongside the technicals. I have included this commentary for Mag-7 stocks, HOOD, and PLTR today.

The reason that the stock market goes up over time is mainly two-fold.

First, businesses that make real revenue grow over time, producing earnings growth. This can be very fast for new, innovative companies or very slow (or even negative) for the incumbent industries and businesses. Generally, unless the company is in some competitive or regulatory trouble (e.g. Nokia after iPhone’s launch), we could expect its growth to settle near or above the nominal GDP in the very long run. Exceptional companies like the Mag-7s have, of course, compounded at a much faster rate for an extended period, and therefore grown their market caps to enormous figures.

Secondly, there is the valuation multiple. You can think of the P/E multiple as “how many years will it take me to get my money back”? Of course, earnings are not real cash flows (earnings are accounting metrics that include non-cash flow items like depreciation or asset revaluation), but we are talking about the framework of thinking here.

Valuation is again mainly determined by two factors. Faster revenue or earnings growth commands higher multiples. Mathematically, the company will increase earnings quickly in the coming years, and there is also higher investor demand for these companies.

Then there are share buybacks and broader macro liquidity. In 2020-2021, valuation soared through the roof because the Fed and the US Treasury opened a floodgate of money into the market. The bear market aftermath, induced by rate hikes and QT, was still felt by the VC and PE industries well into 2024.

Today, valuation across the board is much higher than 10 years ago, driven by greater liquidity. Therefore, we must be careful in doing historical lookback analysis, not to compare apples with oranges.

Housekeeping: I am beginning to build a series of Asset Profiles - a standalone page for each asset. Please bear with me on this. Thank you.

DISCLAIMER: This newsletter is intended for educational purposes only. Any information or analysis in this note does not constitute an offer to sell or a solicitation of an offer to buy any securities. Nothing in this note is intended to be investment advice, nor should it be relied upon to make investment decisions. Any opinions, analyses, or probabilities expressed in this note are those of the author as of the note's date of publication and are subject to change without notice.

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