Key insights
- The author argues that short-term economic events have limited impact on market valuations because the market prices in long-term earnings potential. Temporary disruptions like geopolitical events or soft GDP prints should not significantly alter investment decisions, as they have minimal impact on a company's discounted cash flow, where the majority of value is derived from earnings beyond the next 3 years.
I think we've all heard this phrase at one point or another, but it's never very well articulated as to why.
The reason is simple - the Market prices in the eternity.
If you've ever run a DCF, you'll often find that the majority of a company's value is locked in years 10 and beyond.
Going further than that, next year's earnings only account for ~5% of a company's total value, and the first three years of corporate performance only accounts for 10-15% of value.
***This means that earnings can go to zero for the next 3 years and value should only fall about 15%^1***. It takes longterm impairment to impair value.
So when you see the Strait of Hormuz being shut down or GDP coming in soft or the next inflation print, think about how this effects long term earnings. If they're temporary (i.e., lasting less than 12 months), then it honestly shouldn't effect your decision making progress at all.
^1 Assuming earnings are unchanged for years 4 and-on.