The carnage on Wall Street is reminiscent of Berlin at the end of World War II. The city was absolutely destroyed by months and months of bombings, street fighting and futile scorched earth policies of the Third Reich.
It took years to restore the city to its prior splendor. Will it take years to repair the damage that has been done in the markets? Perhaps, but one thing is clear—stocks have become much cheaper than they were a few weeks ago.
The big question for investors now that the panic has passed will be the future of the economy. Can the consumer hang in there while we go through this process of de-leveraging? (See also: "Consumer Shock: Spending Takes a Turn for the Worse.")
The answer to that question is critically important to those businesses that cater to the consumer. For example, the restaurant space is seeing the direct impact of tighter purse strings. Sales decrease, and as a result, profits drop.
With that dynamic, stocks in the sector have been pummeled. For example, Brinker International, Inc. (EAT) was already seeing pressure on shares before the credit crisis but traded nearly 50% lower in the chaos of the last few weeks.
The selling has been completely justified given the circumstances. The credit crisis is expected to trigger a longer and deeper recession than seen here in the United States in some time. (See also: "A Major Recession is Coming. What To Do Now.")
Slicing the valuation of EAT is a natural reaction to what will be a darker future. How dark will it get? Nobody knows the answer to that question.
As such it is important for investors to mitigate the risk that they are taking when buying shares of stocks like EAT. If the valuation is low enough, a reduction in future earnings will have less of an impact. (See also: "It’s All About Valuation, Or At Least It Should Be.")
At the moment, analysts expect EAT to earn $1.23 in fiscal year 2009 ending on June 30th. That number is a reduction from average estimates of $1.50 only 9 days ago. Given that the stock trades for less than $12 at the beginning of trading on Monday, EAT is valued at just 9.7 times forward earnings.
Of course forward earnings can be higher or lower than estimates. In the current environment with growing unemployment, it seems likely that estimates will be lower than expected.
The credit crisis and its impact has been a shock to the system. Companies have had little time to react to the situation. Wall Street analysts have had little time to forecast the ultimate impact of what has been transpiring.
While it is tempting to want to own a stock like EAT given the low valuation, I would urge caution. Valuation depends on earnings plain and simple. How corporations perform in the next few months will dictate where shares go from here.
At best, it is a 50-50 coin flip.
