#131: Value Comes from Profits

S2N Spotlight

Many think company valuations can climb to the sky and that money falls from trees. Take a look at the blue line below, which represents a log scale of US Corporate Before Tax Profits, going back to 1948. I think the more important thing to focus on is the 12-month year-on-year growth rate (green). Take note how growth mean reverts around 7.47%. Investors need to keep this in mind when valuing a company and a stock exchange index. The long-term average growth of company profits is largely what dictates the growth in valuation. Price discovery on the stock exchange essentially mimics the dance investors have between optimism and pessimism.

I am not making a forecast in the chart below; I am rather laying before you the 2 variables that drive the valuation of companies in the US.

S2N Observations

As a card-carrying devotee to Austrian Economics, I am pretty sure one of its high priests, Ludwig von Mises, is turning in his grave at Australia’s newest law that comes into effect today, giving workers the right to disconnect. In Australia you are no longer obligated to answer your bosses emails or texts on the weekend or after work hours for fear of being prejudiced. I think bringing this into law is crazy and is likely to lead to more labour disputes and litigation than problems caused by a somewhat annoying but necessary evil in today’s hyperconnected and competitive world. Yes, this is something I am guilty of and probably will be for the rest of my life. I don’t get it.

Mises believed that any form of government intervention that distorts the free market impairs the ability of prices to convey accurate information, which is crucial for economic coordination. His work, “Human Action” (1949), lays out a comprehensive case for the superiority of free-market capitalism over government planning.

In the chart below, the US dollar is the only asset on my main watchlist that is down on the year.

Speaking of the dollar, I look at its 1-year rolling correlation with gold. It is interesting that the mean since 1980 is 97%; that is really highly correlated. If you look at the current reading of 83%, there has been a clear breakdown in this relationship.

Cathie Woods, Ark Invest Fund, predicts Bitcoin could reach $1.5 million by 2030.

Would you believe someone whose “innovation” fund is down 70% when the markets that represent innovation are at all-time highs? I don’t like kicking someone when they are down 70% and have destroyed an enormous amount of investor wealth, but making crazy predictions like this is so irresponsible. She is appealing directly to people’s greed.

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