U.S. markets threw a small tantrum on the last trading day of November when Federal Reserve chairman Jerome Powell suggested, in testimony before Congress, that the central bank might accelerate the pace at which it tapers off its monthly asset purchases. Such a move would not only remove excess liquidity sloshing around global markets more quickly than previously forecasted but could also hasten the bank’s plan to start raising interest rates, perhaps as early as the first half of 2022. Not to anyone’s surprise, there was a sell-off in risk assets following the central banker’s remarks.
With the backdrop of a potentially less accommodating Fed, a recent Wall Street Journal article[1] on the latest real estate frenzy caught our attention. It is a classic illustration of where excess liquidity ends up when money is essentially free. According to the article, investment firms are now plowing millions of dollars into parcels of digital land across multiple digital worlds with the expectation that such land will be ‘developed’ into various forms of real estate, not unlike how it happens in the real world. A company featured in the story, Republic Realm, which “develops real estate in the metaverse,” is, according to its co-founder, “trying to reduce risk by buying land in a number of virtual worlds.” Through its two real-world investment vehicles, which raise investor money in real dollars, the company owns “about 2,500 plots of digital land across 19 worlds,” according to the Journal story. Unfortunately for the most digitally-savvy among our readers, we have little to add to the discussion about the value of digital real estate in digital worlds with unlimited supply of digital land. For investors living the real world, however, we hope to shed some light on tangible economic activity and current U.S. company valuations through our favorite equity benchmark, the Barron’s 400 Index (B400).
Following the recently concluded earnings season, we decided to take a closer look at the current economic output of B400’s constituents compared to the period immediately preceding the pandemic-induced shutdowns that began in March 2020, which affected significant portions of economic activity around the world[2]. Our analysis was based on trailing 12-month data across all B400 constituents following their most recent earnings reports and comparable figures through the end of 2019. For most companies, 2019 data goes through Dec. 31, 2019, while for those whose fiscal and calendar years don’t match, the data ends in October 2019. Here’s what we found:
| Barron’s 400 Index Fundamentals | Pre-shutdown (Year-end 2019) | Post-shutdown (Ending 3rd Quarter 2021) | % Change |
| Total Sales (TTM) | $3,788 Billion | $4,705 Billion | 24.2% |
| Total Operating Income (TTM) | $968 Billion | $1,369 Billion | 41.4% |
| Total Net Income (TTM) | $511 Billion | $869 Billion | 70.2% |
| Average Trailing P/E (1-Year) | 24.5 | 22.3 | |
| Average Forward P/E (1-Year) | 19.9 | 20.8 | |
| Median Trailing P/E (1-Year) | 18.9 | 16.4 | |
| Median Forward P/E (1-Year) | 17.2 | 15.6 |
In the aggregate, B400 companies had total sales in the last 12 months of $4.71 trillion, 24% greater than their pre-shutdown levels. In other words, these companies have generated the equivalent of a quarter more in sales in the last year—amid supply chain constraints, limited air travel, and new Covid variants—than they had booked at the end of 2019 when the U.S. economy was humming, and employment was at its best levels in recorded history. When digging further into the income statement the results look even better. The B400 constituents have not only been able to sustain their profit margins, which is particularly difficult to do in an inflationary environment, but have in fact expanded them. Aggregate operating profits for the group totaled $1.37 trillion in the last 12 months, while net profits totaled $870 billion, representing improvements of 42% and 70%, respectively, compared to 2019 year-end figures. When measured in the aggregate, operating margins for B400 companies jumped from 26% to 29%, while net margins grew at a higher clip, from 13% in 2019 to 18% through the most recent earnings season.
Considering this year’s strong equity market returns, is it safe to assume, then, that investors are paying more for these companies’ earnings than they were on the eve of the pandemic? Not exactly. B400’s average trailing P/E ratio currently stands at 22.3, compared to 24.5 for the same group of companies back in 2019. The median trailing P/E, by the way, has fallen even more, from 18.9 in 2019, down to 16.4 today. On the other hand, the companies’ average forward P/E, based on expected earnings for the next full year across all constituents, is slightly higher than it was in 2019, at 20.8 compared to 19.9 two years ago. The median forward P/E, however, fell from 17.2 to 15.6. These ratios compare favorably to the S&P 500 Index, which currently trades at 23.7 times trailing 12-month earnings and 20.9 times next full year earnings per share[1].
In addition to having fundamentals that strike a good balance between growth and value, investors should recall that B400 reshuffles its constituent list twice a year; this means that at its next reconstitution in March 2022, it will be able to replace companies whose growth is faltering or whose valuations might have gotten too far ahead of company fundamentals with a new crop of selections. Put differently, MarketGrader’s continuous GARP-based grading process is expressed in an actionable and dynamic portfolio (B400) that auto-corrects twice a year as it focuses on owning the very best growth companies in the U.S. without overpaying for their shares. Investors in virtual real estate would do well to redeploy some of their digital earnings into this selection of fundamentally sound companies generating real-world value, growth and profits.
[1] Source: FactSet
[1] Metaverse Real Estate Piles Up Record Sales in Sandbox and Other Virtual Realms. The Wall Street Journal, November 30, 2021.
[2] Current B400 constituents differ from the Index’s constituents in 2019 since B400 rebalances twice a year. However, for comparison purposes, we use the same set of companies in our analysis.
