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Jump Back In the Market?

Thank you, AbdulAziz, for this interesting article on today’s investment opportunities from Yahoo News: Finances where you can read the entire article>

Why Stocks Are Dirt Cheap
by Jeremy Siegel, Ph.D.
No one can guarantee the future of the stock market. But I believe that stock prices are now so extraordinarily cheap that I would be very surprised that if an investor who bought a diversified portfolio today did not make at least 20% or more on his investment in the next twelve months.

Valuations Low Worldwide

The case for equities at these levels is compelling. The last time we have seen prices this low was more than 30 years ago, when the US economy was in far worse shape than today.

The table below lists the price-to-earnings ratios of the world’s major stock markets as of October 29. It is taken directly from the Bloomberg World P-E Ratio (WPE) screen. These P-E ratios are calculated based on 2008 earnings, of which the first two quarters have already been reported and the 3rd and 4th quarters’ earnings are estimated. Keep in mind that the average historical P-E ratio of the US stock market has been 15 and that when P-E ratios are ten or lower, investors have reaped generous rewards from investing in stocks.

Except for the tech-laden Nasdaq, the US markets are selling at 10 to 11 times 2008 estimated earnings while European markets, save Switzerland, are selling between 7 and 9 times earnings. Asian stocks are also very cheap, as the Japanese Nikkei Index is selling at 11.4 times earnings, not much different than stocks in Hong Kong, Australia, and Singapore. The Chinese market, which had been selling at over 50 times earnings last year is now selling at a far more modest 15 times earnings.

Bears will claim that these P-E ratios are too low, since earnings will sharply deteriorate over the next twelve months. Indeed, the last 12 months of reported earnings on the S&P 500 Index have fallen to $51.37 from $84.92 a year earlier. On those numbers, the US market is selling at about an 18 multiple.

But this gives a very distorted picture of the market. Aggregate earnings over the past year are greatly depressed by huge write-offs not only in the financial sector but in other firms. For example, Ford, GM, and Sprint, whose aggregate market value is less than 0.2% of the S&P 500 Index, lowered the S&P’s reported earnings by about $12.00, more than 20% of the current aggregate earnings.

Even if these firms all go bankrupt and their stock prices go to zero, it would have a negligible impact on the market value of a well-diversified stock portfolio. The same is true of the financial sector as S&P adds the huge losses in banks that now have almost no value today to the earnings of profitable firms. This means that the P-E ratio of firms that are still profitable is far lower than the ratio calculated for the whole index.

Furthermore, it is a major mistake to use earnings in a recession when calculating the right valuation of the market going forward. That is because stock values are dependent on earnings far in the future, not just those estimated over the next 12 month.

Since stocks have historically sold at 15 times annual earnings, the earnings of the next twelve months contribute only 1/15 of the value of the firm, or less than 7%. The other 93% of the value of stock is realized beyond the next twelve months. Right now the “normal” level of earnings, based on trend analysis of past 15 years of earnings on the S&P 500 Index is $92 a share.

If the average 15 price-earnings ratio applied to these $92 per share normalized earnings, the S&P 500 Index would be selling at 1380, which is almost 50% above its current level. Even if it takes two, or even three years for earnings to return to thetrend line, the normalized valuation of the market is far above what it is today.

Read the rest of the article HERE.

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November 6, 2008 - Posted by | Uncategorized

3 Comments »

  1. […] market news by intlxpatr « How Stocks Work, Sort […]

    Pingback by » Jump Back In the Market? » Stock Prices Online | November 6, 2008 | Reply

  2. the story has shifted a bit right now. the credit crunch is last week’s news and this week we’re all worried about the crash starting to affect the real economy. which will in turn affect the market again of course.

    everyone’s watching for Q4 and full year numbers since most of the market mess occured in october, and companies have cross holdings. its prety much the same story here.

    yes a PE of 15 is cheaper, but i would argue still not cheap enough, if this is going to be as disasterous as everyone thinks. if you can stand a little pain then yeah now is not a bad time,… but i would wait till PE’s hit the 5-7 range. thats when traders wake up, look at prices and say “ok now this is getting stupid”.

    i wouldnt bet the farm right now, but it also wouldnt be too bad if you really couldnt resist picking up a lil something. oh and watch washington on nov 15th, that could have a big impact.

    Comment by sknkwrkz | November 7, 2008 | Reply

  3. It is driving deep into the public conscious, isn’t it Skunk? People are getting seriously concerned. And yet, some things, fundamentals, are still in place, it is fear itself that seems to be causing a lot of the current problems.

    One friend says “is there to be no accountability for those who brought this about?” I think a lot of people are asking the same question, after watching a few small fries going to jail now and then while the big players go free.

    Comment by intlxpatr | November 8, 2008 | Reply


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