Market Update 1/28/25

Priced for Perfection

It took one software release from a dark horse artificial intelligence firm in China named DeepSeek to remind Nasdaq investors yesterday that price matters with investments.  A common stock valuation metric used in the industry is the price-to-earnings ratio (PE). It’s simple math that divides the stock price of a company by its earnings per share.  Since stock by definition is a claim on a corporation’s earnings and assets, the higher the ratio, the more risk an investor takes owning that stock, which was affirmed yesterday. 

 Several of the Nasdaq leaders fell by more than 20% under the threat that more efficient AI software will reduce the need for advanced chips and data centers.  It’s too early to tell if DeepSeek’s efficiencies are real or if a Chinese model will be adopted, but I use the event to remind investors to monitor their risk.  Stocks that trade at extremely high PE ratios are often priced to perfection and as hard as it is for me to admit, perfection is unattainable.  A better method is to acquire high-margin businesses when the PE ratio has decreased, which occurs after a large drawdown.  That’s a model we often incorporate and our clients have enjoyed the benefits.  When a stock goes parabolic, pay attention and consider taking some profits.  Alas, perfection has yet to be achieved.