Here’s a wrap up of this week’s tough market and what’s ahead

Markets finished the week lower as investors attempted to “price in” (find an appropriate valuation level in the face of higher rates) the potential for as many as four Federal Reserve interest rate hikes by year end.

Last week, we discussed what this means for those investors utilizing discounted cash flow models — arguably the most diligent way to determine a company’s intrinsic value — so this week, let’s take a look at valuation multiples, which are also used to determine the “terminal value” in a discounted cash flow (DCF) model.

In general investors looking more near- to- mid-term (6 to 18 months out) will look at a company’s price to earnings multiple, the multiple being placed on a company’s near-term earnings. For example, Apple (AAPL) is expected to earn $5.76 per share this fiscal year — so at a price of $172, shares trade at just below 30x earnings.

However, similar to reassessing the discount rate in a DCF model when rates rise, investors must also reassess valuation multiples. That’s exactly what we saw play out this week, especially in the high fliers and particularly in the names that don’t even have earnings and therefore trade on sales-based multiples.

This is what you hear being referred to when investors mention “multiple contraction,” when interest rates go up (or are expected to go up), investors value companies using a lower valuation multiple. This is also crucial to understand because when a re-rating occurs, we often cannot look to recent highs, especially in the high fliers, as the environment has changed and the market may simply be unwilling to look back at the multiples applied in the lower rate environment. It is also why value (lower multiple names) tend to come into favor as rates rise. Value stocks typically already have low multiples, making the risk of contraction less of an issue.

Lastly, one more term you will often hear in this market is GARP or growth at a reasonable price. This is the term used for those names that strike a nice blend of growth and value and may therefore be able to hold up better when the selling hits the high fliers, while still providing exposure to underlying business growth.

That in mind, while we certainly like GARP-type names, and indeed the mega cap tech names such as Microsoft (MSFT), Google-parent Alphabet (GOOGL) and Facebook-parent Meta Platforms (FB) arguably all fall into this category given their mid-20s to low-30s price-to-earnings multiples combined with high teen to low 20% expected growth rates, we once again reiterate that above all, we want the stocks of companies that “make stuff and do things” because in this market earnings and cash flow are the most attractive attributes of any company, not sales growth as was the case in 2020 and early 2021 when the Fed was being as accommodative as possible.

Here is a quick look at some of the broader market measures we like to keep an eye on: The U.S. dollar index pulled…