Although the stock market is trading very close to its historical average on a valuation basis (approximately 16-17x trailing earnings as of this writing), there are events within the market that make us question what is driving the market.
One example of this involves a deal between Coca-Cola (KO) and Green Mountain Coffee Roasters (GMCR). After an otherwise disappointing earnings report, Green Mountain announced Coke invested $1.25 billion for a 10% stake in the company. Green Mountain will partner with Coke to produce single-serve beverages. Exciting news, but the reaction seems overdone. Green Mountain issued more shares for this transaction and rallied 30% following the announcement. Coke made over $500 million on paper within hours of announcing the deal (recouping nearly half of the original investment). Great for Coke—but what does that say about the state of the market in general?
Short-term movements like the example above, coupled with regular overreactions to quarterly earnings reports, contribute to our worries about the composition of the market’s strength over the past few years. It also underscores the importance to own a high-quality investment portfolio that is built to weather the volatility in the current market environment.