Because stocks have rebounded so strongly despite the ongoing effects of the coronavirus, we’re frequently asked about the level of valuations in the market generally and in the growth-oriented Wasatch strategies more specifically.

In response, we acknowledge the higher prices but we emphasize that many of our companies—tech-related companies, in particular—have actually benefited from the pandemic because they facilitate activities like working remotely, seeing a doctor online, renovating household spaces and enjoying home-based recreation. Moreover, we think these activities will continue at elevated levels even after the pandemic ends because people have become accustomed to new routines—both professionally and personally.

STOCK PRICES ARE FORWARD-LOOKING

Another consideration, which also applies to companies that are negatively impacted by the pandemic, has to do with the forward-looking nature of stock prices. In this regard, think about the discussion from a recent CNBC interview with Wharton School professor Dr. Jeremy Siegel. During the interview, he was asked to assess the effects of potentially lost earnings on stock valuations. Dr. Siegel responded that stocks represent claims on long-term company performance.

More specifically, he said that over 90% of a stock’s worth is generally based on earnings beyond one year into the future. In other words, if a company loses all of its earnings in the current year, the stock price should be down less than 10%. This is a very broad generalization, of course, and from our perspective it assumes the company can stay in business without impairment to its long-term competitive position, without dilution to its ownership structure and without a major increase in debt.

Because so much of a stock’s worth is forward-looking based on earnings well into the future, it can therefore be perfectly rational for a stock to experience a V-shaped recovery in the short term even if it takes the business and the broad economy much longer to get back on track. Additionally, for fast-growing small-cap companies such as those targeted by Wasatch, it’s likely that an even greater percentage of a stock’s worth is based on earnings more than one year into the future.

This is because especially fast growth puts extra emphasis on the future. For example, with the benefit of 20/20 hindsight, we all would have paid what would have seemed like very expensive share prices in the early years of Amazon.com and Netflix if we had known how fast the companies would grow and how long the duration of the growth would be.