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Eye on the Market
July 25, 2011
J.P.Morgan
Topics: US debt ceiling negotiations, a more ambitious European bailout plan (finally), and how large cap growth stocks
and rising corporate profits are patiently waiting for both of them to end
While we're waiting: large cap growth stocks
One day, the melodramas around US and European sovereign debt will end. While we're waiting, one of the asset classes that
looks attractive is large cap growth stocks. As shown below (for a universe of 300 U.S. large cap growth stocks that meet
certain earnings quality and stability factors), free cash flow relative to both revenues and stock prices looks good compared
to the last four decades. This is where we believe investors should be adding exposure if they are underweight versus their
desired equity allocations. This is also an asset class where active management can still provide a lot of value; the dispersion of
large cap growth managers is higher than large cap core, large cap value and international equity manager dispersion.
Q2 earnings season in the US is off to a good start. Nearly
30% of the S&P has reported, and results have generally been
positive. Earnings are beating consensus estimates by almost
4% (7.4% ex-financials), all ten sectors are beating on revenue
targets, and only 7% of companies are reporting below-
consensus earnings. Given earnings expectations for 2011 at
$98.50, the S&P 500 is trading at a reasonable 13.5x forward
multiple. However, y/y earnings growth expectations appear
to be flattening out for both 2011 and 2012 at around 11%-
12%. While Q2 earnings are doing well so far, some company
guidance for the remainder of the year has been below
consensus, which would be consistent with the recent batch of
reports indicating a slowdown in manufacturing and service
sector surveys.
Michael Cembalest
Chief Investment Officer
Congressional Budget Office
Office of Management and Budget
European Financial Stability Facility
СВО
OMB
EFSF
FICA
Federal Insurance Contributions Act
EU
European Union
IMF
International Monetary Fund
IIF
Institute of International Finance
ECB
European Central Bank
EMU
European Monetary Union
AMT
Alternative Minimum Tax
Attractive valuations for US large cap growth stocks
Percent
9%
8%
7%
Nominal free cash yield
6%
5%
4%
3%
2%
1%
0%
-1%
-2%
T
Post-dividend free cash flow margin
'71 '74 '77 '80 '83 '86 '89 '92 '95 '98 '01 '04 '07 '10
Source: Empirical Research Partners.
A White Castle hamburger is smaller than its competitors' offerings, measuring 2.5 inches square.
The material contained herein is intended as a general market commentary. Opinions expressed herein are those of Michael Cembalest and may differ from those of other J.P.
Morgan employees and affiliates. This information in no way constitutes J.P. Morgan research and should not be treated as such. Further, the views expressed herein may
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