Stocks are getting clobbered since President Donald Trump announced new tariffs last Wednesday. The problem for investors in search of bargains: It’s hard to know which names are actually on sale. The standard way to value stocks is a forward price-to-earnings multiple, based estimates for the coming 12 months. Take the share price and divide it by the consensus earnings per share estimate on Wall Street, and you have the P/E. In ordinary times, it’s quite common to look at stocks with falling P/Es and determine that a more attractive entry point has arrived. “This stock has gone on sale,” is a typical refrain. “It’s trading at a discount to its history,” is another one. But in moments of widespread uncertainty, like the one now upon us, the standard playbook is difficult to rely on. The heart of the matter is that investors can no longer trust the “P/E,” especially the earnings estimate ingredient. And the erosion in trust occurs in more ways than one. For starters, investors are generally willing to pay a higher P/E multiple for stocks when things are going well. The economy is expanding, earnings are growing, interest rates are stable or, at least, not going up — for the most part, that kind of world will lead to “multiple expansion.” On a company-specific level, accelerating revenue and earnings growth tends to be rewarded with a higher multiple, even if the macroeconomic picture is less than stellar. When the reverse is true — fears of a recession reign supreme, and therefore earnings growth might be slowing or even contracting — investors are going to be more cautious. Sentiment turns sour. And one way that manifests is that they will no longer be willing to pay the same multiple as before. Risk is elevated, and so they adjust accordingly, leading to “multiple compression.” This generally plays out at both the index and individual stock levels. Sure, the stock is now cheaper than it used to be, but with sentiment on the decline, other investors aren’t willing to pay that higher price anymore. It’s like seeing a good price on a car that just has been deemed unsafe for the roads — are you sure you want to buy it? The other place where trust in the P/E breaks down is on the earnings estimate itself. As a stock’s share price declines, it is really only getting cheaper on a P/E basis if the earnings estimates themselves do not fall in lockstep. If Company ABC’s stock went from $100 a share to $85, but throughout that decline, it is still expected to earn $5 a share in its fiscal year — and there’s been nothing happening in the world or with the company to suggest that it can no longer earn $5 a share — then the stock got cheaper. Its P/E went from 20 to 17, and now it is trading at a discount. What is happening with stocks inside the Club’s portfolio right now — and practically the entire market — is that investors are much less certain in whatever they expected their companies to earn before Trump’s steeper-than-expected…
Read More: Stocks are falling but are they getting cheaper? There’s no easy answer