When I first got married, my wife and I were living on a shoestring budget.
It was my last semester in college and I wanted to graduate debt free. So I was working several jobs and pinching pennies as tightly as I could.
While I grew up in a frugal family and was used to making money stretch, my wife didn’t have much experience with that.
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I distinctly remember going to the grocery with her and explaining that it’s not just about the price on the particular item we were putting into our cart… It was about HOW MUCH YOU GOT for that price.
So often, the small can of soup would cost more, and you would pay less per ounce if you bought the bigger can and made it last.
Most people don’t realize that stocks are the same way.
It’s not really about the quoted price for a particular stock. It’s more about WHAT YOU GET when you buy shares.
When you buy a share of stock, you own a small piece of that company. And specifically, you own a piece of the earnings that the company will generate.
So investors — just like grocery shoppers — should pay attention to what they’re paying for every dollar of earnings a company will generate. Not just the market price for that stock alone.
Today, I want to explain why this is one of the best times we’ve had in several years for those of you who are shopping for great stocks at a reasonable price…
One of the most common ways for us to evaluate what we’re actually getting when buying shares of stock is the price earnings — or PE ratio. This basically tells us how much we’re paying for each dollar of earnings that a company generates.
So if you’re buying a stock with a PE of 20, you’re paying $20 for every dollar of earnings that company makes.
For example, if a company is expected to earn $3 per share, and the price of the stock is $60, you’re paying $20 for every dollar the company is earning.
On the other hand, consider a company that only earns $0.50 per share and trades at $25. That stock may seem cheaper than the $60 stock. But you’re actually paying $50 for every dollar that the company earns.
So in this case, the $25 stock is actually more expensive than the $60 stock, because you’re getting a lot more for your money with the $60 stock.
And in today’s market, we’re getting a LOT when we buy shares.
Today, the broad U.S. stock market is trading at about 16 times expected earnings for next year. So for the average stock, you only have to pay $16 for every dollar in annual earnings.
A couple really important things to note here.
First, this is the cheapest stocks have been since 2014. That means when you buy shares today, you’re getting much more corporate profits for every dollar that you spend.
Second, corporate profits are actually RISING. And estimates for future profits keep getting revised higher — more on this in a moment.
See, back in 2014 when stocks were this cheap, investors were worried that global growth was slowing and that corporate earnings were going to pull back. And that’s why investors weren’t willing to pay as much for stocks.
That’s not the case today.
Today, with so much growth, it’s like you’re getting even MORE for your money. It’s like going to the store and buying that big can of soup for a cheaper price, and then the clerk says they’ll keep delivering more soup to your house in the weeks ahead.
So based on the actual numbers — what you’re REALLY getting as an investor today — you shouldn’t be worried about the market pullback. Instead, this looks very much like a great buying opportunity.
This week, big banks will be kicking off the first quarter earnings season. Remember, this is the first earnings season that actually includes lower tax rates following last year’s tax cuts. So it will be very interesting to see how each company’s earnings are affected.
I’m excited about the big banks this quarter in particular because I expect them to reveal a hidden source of profits that not many people are talking about right now.
Remember how the market started selling off in early February? And how stocks have been extremely volatile ever since?
Well, big investment banks have trading desks that help move large blocks of stock in and out of the market. So when big investors like mutual funds, pension funds and endowments need to place big trades, they call up the trading desks at these big blue-chip banks.
This quarter, I expect big banks to have especially high earnings thanks to tax cuts, higher interest rates, less regulations — and now also thanks to more trade desk profits. So watch for strong reports from the big banks over the next several trading days.
J.P. Morgan, Citigroup and Wells Fargo are all scheduled to report earnings this morning, followed by Bank of America and Morgan Stanley next week.
This article originally appeared on The Daily Reckoning.