Are there Monsters Under the Bed?

The business headlines are covered with stories of last year’s sexy darlings tumbling out of bed. Crypto coins, miners and brokers have fallen as much as -80%, most SPAC’s (blank-check Special Purpose Acquisition Companies) are way below their initial offering prices, Chinese Internet stocks are down -70%, and the “meme” stocks like GameStop are off about -65%. Not to mention the outright false pricing and theft occurring with NFT’s (Non-Fungible Tokens) and digital properties in various Metaverse virtual reality worlds like Sandbox and Decentraland. When previously high-flying investments fall out of bed, it is an especially good time to make sure there are no surprises lurking in a portfolio. The Dow Jones Industrial Average and S&P 500 are down -9% and -14% for 2022 respectively, and the technology-focused NASDAQ has fallen consistently since last fall, so maintaining portfolio quality is critical as we move through 2022.

A good starting point is to evaluate the S&P 500 to see how stocks compare. Companies are facing rising interest rates and persistent inflationary pressures. There are actually 504 stocks in the index since there are four companies with two different share classes (Google, Fox, News Corp, and Under Armour). Companies are facing rising borrowing costs as the Federal Reserve raises interest rates and slows bond purchases, so debt:equity is a good ratio to review. Companies with excessive outstanding debt eventually have to pay off their loans, which becomes a drag on earnings. As of today, there are only 18 companies in the S&P 500 with zero debt, and there are a whopping 152 companies that owe more in debt that the total equity value of the company. Persistent inflationary pressure will challenge companies in delivering consistent earnings growth. There are only 90 companies in the S&P 500 with 5-year earning-per-share growth above +25%, and 183 are below +5%, with 19 that are negative. Out of 500 companies, wouldn’t it be better to choose financially sound companies with strong balance sheets and consistently growing earnings? Index funds are a great vehicle for those just starting to invest in the stock market. We use SPY, the S&P 500 ETF (Exchange Traded Fund) as a way to make tactical moves into the market at opportune times. But the core of the money we manage on behalf of clients is invested in concentrated portfolios of stocks with little or no debt, good earnings growth and rock-solid cash-flow.

There are many ways to construct portfolios and select stocks that deliver solid performance over time. In my opinion, and what has consistently worked well for both the Pawleys Dividend Fund and the Pawleys Growth Fund, is to balance sector weightings and choose stocks of companies with little or no debt, good earnings growth, and rock-solid cash flow. We don’t beat the markets every year, but the exceptional long-term numbers speak for themselves, and our clients can sleep well.

Source: yahoo! finance, Refinitiv

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