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Q3 Earnings Are Coming In… Head for the Exits??

The new earnings season has started, and already several big names have revealed their earnings to the awaiting financial masses.   Microsoft, Google, McDonald’s have all weighed in.  More than half of the Dow Jones index has issued guidance for the 4th quarter, and none of it is looking good.  (edit: well, surprisingly Facebook turned in a positive surprise… good for them!)

So the question remains, should we be heading for the exits?

Personally, I think you can make a case either way.

When you buy a stock, you are buying a piece of a company’s earnings.  If you buy a share of Google, you are buying into the $32ish that the company made per share over the last 12 months, hoping that earnings per share will grow, or that Google will start to pay out a dividend.

But a share of Google costs a lot more than $32.  In fact it costs around $675 per share.  That difference is called the Price to Earnings (PE) multiplier.  At present, people wanting to invest in Google are willing to pay $21.20 for each dollar that Google earns.  Both parts of the equation carries equal weight.   Share price = Earnings per Share    X   PE 

And while the earnings per share of the overall market look to be anywhere from flat to a small decline overall, due to the Federal Reserve flooding the asset markets with easy money, the amount of money that an investor (or much more likely, an institution) is willing to pay for a dollar of those earnings is still destined to increase, because each month there are way more dollars having to compete for a share of any single asset.

Now does that result in overall stock prices going up or going down?  That’s the part that’s hard to say.  One side of the equation is pulling down, and the other is pulling up.    Whether the market increases or decreases depends on which pull is stronger.   But whatever the result, we are likely to see a lot of generally sideways action until earnings pick up again.

So how does make money when the market is going nowhere, or close to it?

Stay tuned, kids.

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