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Tackle Today: The Silver Lining of Sideways

May 25, 2021

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When earnings play catch up


Amazon stock first hit $3,250 on July 13th, 2020. It was red-hot and had been ripping higher for months. Then, it ran out of gas. Shareholders have been stranded at $3,250 for nearly a year now. Sideways is the new up.

It can be frustrating when a glorious uptrend transitions into consolidation. Directional trades sour and cash flow plays become the only game in town. But there is a silver lining to the months of neutrality. It allows earnings to catch-up to price.

Fundamental analysts like to value a stock based on its price to earnings (P/E) ratio. If a stock is trading at $100 and has annual earnings per share (EPS) of $10, then we say it is trading with a P/E ratio of 10. In other words, it has a 10 multiple.

When Amazon zoomed to the moon last year, it outpaced its earnings growth considerably. As a result, the P/E ratio increased and signaled the stock was becoming more expensive from a valuation perspective. Its multiple was expanding. Do you know what’s happened in the year since the stock hit the snooze button? Earnings have increased. Here are the past four quarters’ EPS: $10.30, $12.37, $14.09, $15.79.

What happens when P goes sideways while E rises? The P/E ratio falls. Said another way, the multiple shrinks.

Amazon has been growing into its lofty price. That is perhaps the most important silver lining of sideways.


Chart of the Day

Amazon’s P/E Ratio

Though Amazon’s share price hasn’t budged, it’s actually a great deal cheaper than it once was. The reason? Earnings have exploded. The P/E ratio has shrunk dramatically from 106 to 59.

Video of the Day

Onboarding with Coach Frank

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