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the S&P, P/E, P/forwardE, P/B, P/S, etc.

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June 22, 2009 – Comments (12)

Well gentleman and ladies (I, counter convention, put gentlemen ahead of ladies as I have surmised from my time on CAPs that the gents outnumber the ladies)

I have sat down this evening and added up the P/E, forward P/E, price/sales, and price/book of the S&P 500.

I used Zacks Research Wizard and, to fill in the blanks where Zacks didn't have data, Yahoo finance.

The stats are these:

Price/sales on the S&P = 0.96

Price/book on the S&P = 1.9

Price/earnings, forward, on the S&P =  12.6

Price/earnings, current fiscal  year =  14.5

Historically the average p/e on the S&P over the last 50 years is 16.8, calcualted fromhttp://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/spearn.htm 

It could be concluded that the S&P is below its historical average p/e.  Draw what conclusions you will from this excercise.  AIG is incorrectly reported by ZACKs, reporting earnings next year nad this year.  Entering approximately AIGs losses from the last 12 months raises the current p/e to 17.  a 2.5 point increase...

this highlights that what I've repeatedly said is approximately correct.  Eliminate the wild one-time losses form AIG, the car makers, and you have a situation where stocks are cheap relative to historical averages, even after the "rally" (which shouldn't be called a rally, but rather called a bounce back to the basic trough we've been in since october).

A price/sales of <1 seems reasonable, certainly not exorbitantly expensive.  A price/book of less than 2 seems also reasonable, certainly not exorbitant.  And a p/e of 12-15 seems reasonable.

The conclusion is that stocks may well be reasonably priced now, neither expensive nor particularily cheap, but below historical averages.  If we filter out 1998-2000, to eliminate the tech bubble, the historical average p/e is 15.X, still above where we are today if we filter out AIG and well above where analysts expect us to be in the next 12 months.

The point of this excercise was to assess whether we were overpriced historically or underpriced.  The conclusion is that we are slightly below historical pricings, and that if the S&P regressed to historical pricings we would be at roughly 1100.  

I hope thats useful to someone. 

12 Comments – Post Your Own

#1) On June 22, 2009 at 1:28 AM, checklist34 (99.73) wrote:

to add some explanation of the calculations:

1.  I added up the earnings and added up the market caps and divided (same for p/b, and p/s) I did not include the S&P weighting factors.

2.  data is from Zacks Research Wizard and Yahoo Finance except as noted for AIG above.  

3.  The p/B of my portfolio is about 3-4x lower than the p/b for the S&P 500 as calculate dabove, that has to be a reasonably good sign indicating that my picks have more upside than the index itself.  Always keep in mind the lessons of Dreman and others on picking stocks...

4.  this is not a prediction of short or medium term market movements, the market in the short or medium term has little to do with fundamentals, reality, or anything else

5.  the dividend yield that I calculated from Zacks was 2.4%, lower than reported for SPY on yahoo (2.8%) so perhaps the Zacks figures aren't overly optimistic.

6.  the historical average yield on the S&P is 3.2%.  The standard deviation is 1.1%.  So we are below the average yield, but not more than 1 std deviation below.  .... 

taking aleap of faith an dassuming htat many of hte recent dividend cuts are temporary, we come to the conclusion taht while the price/dividen is not great right now, the price/restored divi's is good.  In fact price/restored divi's would be the best in 15-20 years.  

Price/divi on the S&P has been declining in the last 20 years and hasn't exceeded 3% since 1991.  It last exceeded 4% in 1984.  

7.  the markets PEG is roughly 2

happy hunting

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#2) On June 22, 2009 at 1:57 AM, LongTermBull (94.74) wrote:

Wow, imagine this, someone actually doing their own research instead of taking statistics on blind faith.  Impressive.  Now I am going to take your statistics on blind faith :P  

BTW, speaking of Dreman, I read most of that book.  Interesting read.  I thought he had a lot of filler in there that wasn't necessary, showing example after example to drive home one point.  But the meat of it was quite eye opening.  Can picking stocks really be that easy?

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#3) On June 22, 2009 at 2:15 AM, usmilitiadude (30.66) wrote:

www2.standardandpoors.com/spf/xls/index/SP500EPSEST.XLS

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#4) On June 22, 2009 at 2:27 AM, gmXmkttiming (28.25) wrote:

this isn't GMX speaking but fwiw

You aren't using GAAP earnings. Believing a company's non-GAAP earnings is blind faith imo

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#5) On June 22, 2009 at 8:30 AM, Entrepreneur58 (40.30) wrote:

The problem is that the only thing holding up the entire US economy is massive government spending.  Do you really want to invest in an economy which is rapidly being taken over by the government?

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#6) On June 22, 2009 at 10:14 AM, checklist34 (99.73) wrote:

gmx, I can't comment on earnings outside of stating their source, I didn't audit each company individually.  I suspect that if each company was individually audited and one-time losses (i.e., lets write stuff down now, nothing left to lose on the share price, throw out the kitchen sink) things, AIG, auto's, and non-ultimately-realized mark to market losses were filtered out, we'd wind up with a fairly decent outlook.  Thats a project I can't get done in a day though... 

militiadude, thanks for the link I wasn't aware that S&P ponied up such data.  

a nice commentary on how challenging estimating fair value of the index via p/e is here:  

http://www.comstockfunds.com/default.aspx?act=Newsletter.aspx&category=SpecialReport&newsletterid=1356&menugroup=Home

Aside from earnings, by far and away the most challenging thing to assess, the price/book of 1.9 is below the historical average of 2.4.  The 2.4 figure is taken from comstockfunds website.

I've not been able to locate a historical price/sales ratio.

From a table of GDP taken from here and historical end-of-year S&P closing prices we find a historical average of 8.5% (S&P value divided by the GDP in billions.  Year end 2008 (S&P at 903) we were at 6.3%, the lowest figure since 1990.  This metric was above 10%, generally, from the mid 50's through the 60's.  It then dropped in the mid 70's to the 4-6% range and stayed there through the 80s.  It then surged through the 90s peaking in the tech bubble and generally staying above 10% since until now and the dip in 2002.  With the S&P at 670 it was at 4.7%, which is not an all time low, but is the lowest figure since 1984.

so thats what I've got.

It appears that, excepting the very difficult to asses p/e of the broad index, we are below historical averages for valuations.  We are also below the long term S&P trendline.

History has taught us that just because things are too expensive doesn't mean they can't go higher (nasdaq bubble left alot of value investors jaws' on the floor in 1998 and 1999) and just because things are cheap doesn't mean that they can't get cheaper.  What I'm saying is that this post or analysis cannot predict market movements over the short or intermediate term.

But it does appear that we are cheap by historical standards.  price/book, possibly price/earnings but... i've seen estimates of p/e for the market anywhere from 12 to 100's, possibly price/sales but I can't find the historical #, and definitely on price/GDP.

From this graph it looks like we are probably not much below the historical price/sales ratio.  

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#7) On June 22, 2009 at 10:59 AM, checklist34 (99.73) wrote:

hey LTB, thats exactly how Dreman's book struck me too.  "can it really be this easy"

Something interesting, I don't have a link, but...

someone did a study with rats and humans and flashing lights.  a light flashed green or red 75% of the time being green, 25% being red.  

Rats got some food if they picked the right color, people got a point or whatever.

Rats beat people.  They, after however long, simply sat there hitting green, winning 75% of the time.

People tried to find a pattern.  If 5 greens in a row had come they'd pick a red, etc., etc., etc., and wound up a bit below 75% accuracy.

I think what Dreman is saying is basicaly "be a rat", just pick green over and over and take your 75%

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#8) On June 23, 2009 at 12:22 AM, LongTermBull (94.74) wrote:

Ya, I think that is what he is saying.  I think the real problem with human nature is greed.  Would making 17% a year for the rest of your life be good?  Of course, but people are always looking for the get rich quick.  Why take 17% when you can get 30, or 40, or 50?  Or hit the real home run and find that small cap that will one day be a behemoth.

I actually use p/fcf ratio as my main fundamental analysis, though I also look at cash to debt as I think this is a good sign of how a business can survive in tough times (such as what we experienced the last year and a half).  I had also been using a DCF valuation but after reading that book I think I may scrap it.  Just use p/fcf as a similar ratio to p/e, anything under 10 is cheap, 10-15 is decent, and anything over 15 is too expensive.  

Dreman seems to like large caps for this, but I don't see why it wouldn't work with small caps as well, maybe even better.  Especially in our current market enviornment.  Once stocks are no longer cheap I think moving into large cap dividend payers may be best as a measure of safety, still looking for ones that are low on the ratio sides.

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#9) On June 23, 2009 at 4:05 AM, checklist34 (99.73) wrote:

thats exactly, exactly what dreman is saying, LTB. 

we wind up losing (to the market, losing in absolute terms, whatever) because we won't just take the odds as laid out.  We always get greedy and try to find a better way, a better system, a better return.  And lose for our trouble save perhaps some really talented and dedicated persons like perhaps Soros or whoever.

I would like to use price/cash flow but it can be confusing at times.  Do you use operating cash flow?  That seems to make more sense. 

My whole strategy for this bear market boiled down to Dreman like simplicity:

1.  buy cheap stocks.  I defined cheap via price/book, price/forward pe (not trailing pe), price/historical price (like ASH, my all time favorite pick, was about 50% below its all time 25 year low and not a bk risk).

2.  diversify...  to avoid losing out big on any one pick.  I'm not sure I came out ahead for diversifying or not so far... 

3.  focus on small caps.  history says that when markets come out of big bearish periods small caps rally significantly more than big caps.  so i play the odds

4.   avoid stocks that are in favor / in vogue.  CHK is one of my worst picks to date.  Its the only stock I ever bought where EVERYBODY liked it.  TMF had a target price of like 45 bucks, Zacks had like 39, S&P had like 50, Stifel had like 50, yahoo analysts had a super buy rating on average of like 1.8.  And its basically gone nowhere.  

5.  i added one human element and that was I tried to filter out stocks with significant bankruptcy risk.  Did I come out ahead for this?  Or would some of the super-cheap stocks that go BK be outweighed by super-cheap ones that live and go up 10x?  Who knows.

But I tried to just play the odds.  Just play the odds, just play the odds.  

Its worked out better than I could possibly have believed...  with some room to run in basically all of the names from here except a few.  

Hopefully it stays that way.  

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#10) On June 23, 2009 at 4:07 AM, checklist34 (99.73) wrote:

also, price/earnings and its really debateable calculation aside...

we are, for the first time in almost 2 decades, below the historical averages for

1.  S&P/GDP

2.  price/book on the S&P

3.  price/sales on the S&P

The bear market in 2002 just dropped us to the average, this one has taken us well below (even today, after the rebound to the 850-950 range, far below at the march lows).  

From a value perspective it does appear this is the cheapest stocks have been in a long time.  That can't be a bad thing.

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#11) On June 23, 2009 at 11:02 AM, LongTermBull (94.74) wrote:

I would like to use price/cash flow but it can be confusing at times.  Do you use operating cash flow?  That seems to make more sense.

I use free cash flow.  I like free cash flow, it is the money the company has left over after it pays all bills.  If every month after you paid all your bills, bought your food, put gas in your car, etc. and you had money left over, that would be a good thing.  That is how I look at a business, after every last penny is spent on the necessities do they have any left over?

As for diversifying I am not a big fan of it.  First, I don't have enough money to buy 50 stocks.  Second, usually out of those 50 there are 5 or so that are great, a bunch that are just Ok, and probably another 5 or so that suck.  I just try to buy the 5 great ones which I define as the lowest p/fcf stocks.

From a value perspective it does appear this is the cheapest stocks have been in a long time.  That can't be a bad thing. 

Ya, it makes absolutely no sense to me when people say stocks are not cheap right now.  Unless you believe the economy will never rebound and earnings will never pick back up it is hard to say stocks aren't cheap.  

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#12) On June 23, 2009 at 6:53 PM, checklist34 (99.73) wrote:

I'll share my pick for the greatest investment story I have ever heard, it relates to diversification, one good man finally getting his after a long life of living near poverty, and luck.

My old man was as poor as probably anybody in the country over the last 30 years.  In the 18 years I was growing up the total household income for a family of 5 was about 300 grand.  Its a farm thing, and he being of unusually high principles refused to accept any form of aid available to farmers (so he wouldn't sell grain if it was supported by an artificial price floor, wouldn't accept any form of payment).  He just thought if a guy can't live on his own he doesn't deserve to live and then put his life where his mouth is. 

Well... many years ago I bought Dreman, and he borrowed it from my apartment when I was even more broke trying to get a business to turn profitable.  He took it pretty to heart... and when grain prices peaked a year or 2 ago he entered into some futures contract for barley or other, at a very good pric.e  Then he planted the entire farm to barley, barely made malting grade, and made six figures in a year.

Then he held all the grain, delievered it in 2009 (so as to delay taxes), sent some money down and asked me to invest it for him, then in february when it was really crashing he basically sent every cent he had on the planet including some debt (i think, i'm not intimately privy to his finances) and on March 5 (i'd been very slowly putting it into stocks) he just said "thats low enough, put it all in tomorrow".

So I did, into what I considered the 5 or 6 surest bets ont he market - DOW, GE, ASH, AA, XL, and some more.

He tripled his money in 60 days, and one old man is basiaclly all set to retire. 

He did better than I did, in no small part because I put his money into a few sure bets rather than spreading it out across many bets.   

If the market takes another severe downturn, I will re-arrange my portfolio into something less diversified...  and come out with the 5-10 or 15 surest bets I can find.  :)

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