Posts Tagged ‘P/E Ratio’

STOCKS ARE CHEAP, BUT THIS METRIC DOESN’T WORK?

STOCKS ARE CHEAP, BUT THIS METRIC DOESN’T WORK?

Courtesy of The Pragmatic Capitalist 

WHEN PEOPLE THINK OF IMPORTANT JOBS THAT CAN NOT BE LEFT OUT OF OUR LIVES THEY DO NOT NORMALLY THINK OF WASTE COLLECTORS. BUT DURING A HAULERS STRIKE GARBAGE PILES UP AND BEGINS TO SMELL. THERE IS NOWHERE TO PLACE IT ALL AND PESTS RUN RAMPANT AS THEIR AVAILABLE FOOD BECOMES ABUNDANT. DUMPSTERS OVERFILLED TRASH WASTE HAULER STRIKE

I’ll be frank – I have a special place in my heart for the PE ratio and it is the same place where all the things I hate are stored.  This simple to understand metric has, in my opinion, resulted in more misguided Wall Street thinking than just about any metric in existence.  A quick glance at the breakdown of the PE ratio shows serious flaws at work here.  It is basically a moving price target (which is never correct unless you still believe in EMH) divided by the earnings estimates that are created by analysts who have literally no idea where future earnings will be.  In other words, you might as well pick random numbers out of a hat and divide them and then go buy or sell stocks.  Naturally, proponents of the PE ratio will say that you shouldn’t use forward PE’s, but to those people I have to respond: do you always drive through your rear view mirror?  The numerator (or market price in the PE equation) could care less about past earnings so it’s less than helpful in telling us where future prices might go.

What disgusts me even more about this metric is its incessant use in selling buy and hold strategies.  You can’t read a book on value investing or buy and hold without running into the PE ratio.  “The market is cheap – stocks for the long-run!”  You’ve probably seen this slogan on every mutual fund pamphlet you’ve ever read.  Your stock broker no doubt thinks the market is “cheap” right now.  The PE ratio has become the sales pitch of an entire generation of sales people who are just herding small investors into fee based products.  “Did you know Warren Buffet is a value investor?”  “Just buy cheap stocks and hang on.  Your status on the list of the world’s richest is in the making!”  Or so goes the old sales pitch.

So, I wasn’t surprised to open Yahoo Finance this morning to see the following headline arguing that stocks are cheap according to the PE ratio.  But just two articles down is an article from the WSJ arguing that the PE ratio doesn’t work in this environment.  You can’t make this stuff up.  According to the article:

“Not only is the P/E


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P/E Ratio: Deflators and the LONG Term

P/E Ratio: Deflators and the LONG Term

Courtesy of Jake at Econompic Data 

Doug Kass via The Street (hat tip Abnormal Returns):

There exists numerous price/earning multiple deflators and non traditional headwinds to growth. These factors don’t necessarily prevent an extended bull market, but they will most certainly deflate price/earnings multiples and put a cap on the market’s upside potential:

  • rising taxes
  • fiscal imbalances in federal, state and local governments;
  • the absence of drivers to replace the prior cycle’s strength in residential and nonresidential construction
  • the long tail of the last credit cycle (Greece, Portugal, Spain, etc.)
  • inept and partisan politics

Lets take this concept and look at how it fits in over the LONG term (i.e. based on history, do we seem extended). The chart below shows the CAPE (Professor Shiller’s Cyclically Adjusted Price / Earnings Ratio), as well as the twenty year average of the same going back 100 years to 1910 (actually, the 20 year average data goes all the way back to 1890).

historical p/e ratios

Note that in previous cycles we have seen the CAPE move well below 10 at the low, whereas this cycle "only" hit a low of 13 in March ’09. Interestingly enough, that 13 CAPE ratio is higher than each of the three 20 year average lows, seen at each low point throughout the last century. 

 


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Analyzing Corporate Margins As S&P500 Free Cash Flows Hits Record

Pragcap examined the same phenomenon this morning from a different perspective, that of earnings season surprises. – Ilene 

Analyzing Corporate Margins As S&P500 Free Cash Flows Hits Record 

Courtesy of Tyler Durden at Zero Hedge 

In the recent multiple expansion run up, one of the largely ignored factors has been the dramatic rise in corporate margins, be they Gross Profit, EBITDA, Net Income or unlevered Free Cash Flow. Of course, all this has been a function of massive cuts in corporate overhead as most companies have laid off the bulk of their workers, resulting in a seemingly stronger bottom line. In the meantime, assorted stimulus programs by the government have prevented revenues from crashing, thus boosting EPS, on both a historical and a projected basis.

We demonstrate the dramatic surge in margins by scouring through the S&P 500 companies over the past 3 years, and question just how sustainable this margin pick up is. As more and more analysts predict that future margin expansion is sure to drive the market higher, we can’t help but wonder 1) with stimulus benefits expiring and excess liquidity approaching an inflection point (especially in China) who will keep the top line strong, 2) as companies are forced, as a result, to hire more workers in order to drive sales, how will operating margins maintain their stellar performance, and 3) how will a decline in margins be justified from a multiple expansion standpoint. Lastly, we parse through the thoughts of William Hester of Hussman funds, who has some very critical observations on this very relevant topic.

As the chart below demonstrates, virtually every margin metric is now trading at or above its 3 year average.

One notable observation is the unlevered Free Cash Flow margin, which at 12.6% is now at a recent record. We have preciously discussed how companies have extracted major cash concession by squeezing net working capital, which is likely a factor in the disproportionate rise in FCF margins relative to all other metrics. The immediate result of this cash conservation has been of course the dramatic increase in corporate cash balances, which some have speculated is merely in anticipation of much higher corporate tax rates down the line, as well as general austerity as the reality of America’s insolvency trickes down to individual corporations.

The take home here is that margins have likely little room left to grow. This is especially true…
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IS THE MARKET FAIRLY VALUED?

Pragcap shares a tool he uses to answer the question, 

IS THE MARKET FAIRLY VALUED?

Courtesy of The Pragmatic Capitalist

Maria Shriver's 2008 Women's Conference

I’ve long argued that most valuation metrics are fraught with pitfalls that the average investor too often falls for.  What is often described as “value” is too often a bloated price divided by some analyst’s guesstimate.  The myth of “value” and the dream of becoming the next Warren Buffett (see the many myths of Warren Buffett here) has resulted in untold stock market losses over the decades and/or misconceptions of adding “value” to a portfolio that most likely doesn’t outperform a correlating index fund after taxes and fees. Nonetheless, the PE ratio and other faulty valuation metrics remain one of the primary sources of investment strategists, stock pickers and market researchers.

While I am no fan of valuation metrics, I do happen to be a student and believer of mean reversion.  In an effort to attach a “value” to this market I’ve used an old Jeremy Grantham tool to see where we are today.  Grantham is a big believer in the cycle of corporate profits and specifically profit margins.  As regular readers know, one of the primary reasons why we have been bullish ahead of the past 5 earnings seasons was due to the expansion in corporate margins and very low analyst expectations.  Analysts became extremely negative in Q4 2008 and severely underestimated the pace at which companies were able to cut costs and support the bottom line.  This stabilization in corporate margins set the table for the massive rally in stocks as profits continued to expand at a far faster pace than anyone expected.

Corporate margins are extremely cyclical.  As companies expand their businesses and revenues grow they are able to better manage their costs, hire personnel, etc.  But if the economy weakens for any number of reasons revenues will contract, costs will remain high and margins will ultimately contract.  Businesses are then forced to cut costs in order to salvage profits.  In other words, margins are constantly expanding and contracting with the business cycle around the mean.

Over the last 50 years corporate profit margins (corporate profits/GDP) have averaged 9.5%.  If we multiply GDP by the average margin growth we can create a long-term trend of what corporate profits should look like.  We can then compare actual corporate profits to this result in an effort to see whether…
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DEEP THOUGHTS FROM DAVID ROSENBERG

DEEP THOUGHTS FROM DAVID ROSENBERG

Courtesy of The Pragmatic Capitalist

Rosey was really on point yesterday with these excellent thoughts:

We realize that the nerdy economics term of “The Great Recession” has already been coined, but let’s face facts — this was not a recession, nor was it great. It was not the Great Depression, either, but it was (is, in fact) a depression. So let’s call it the “Not So Great Depression”.

Now what makes a depression different than a recession is that depressions follow a period of wild credit excess, and when the bubble bursts and the wheels begin to move in reverse, we are in a depression. A recession is a correction in real GDP in the context of a secular expansion, which is what all prior nine of them were, back to 1945. But this was not a mere blip in real GDP — it is a post-bubble credit collapse. This is not a garden-variety recession at all, which an economic downturn triggered by an inflation-fighting Fed and excessive manufacturing inventories. A depression is all about deflating asset values and contracting private sector credit. In a recession, monetary and fiscal policy works, even if the lags can be long. In a depression, they do not work. And this is what we see today.

The stock market typically rolls over shortly after the last Fed rate hike at any given cycle. That didn’t happen this time. The Fed last hiked rates in the summer of 2006 and yet the stock market didn’t peak until after the first rate CUT … that does not happen in a normal cycle.

Even with a 0% funds rate, the economy could still not turn around, and that is exactly what happened in the 1930s in the U.S. and in the 1990s in Japan. When the central bank takes rates to zero and that does not do the trick in helping the economy or the markets find the bottom, and then has to engage in an array of experimental strategies and radically expand its balance sheet, then you know you are in a depression.

Moreover, when, a year after the onset of quantitative easing, we see money velocity and the money multipliers still in decline, then you also know that the liquidity is not being re-circulated in the real economy but perhaps finding


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Make Sure You Get This One Right

Make Sure You Get This One Right

Courtesy of John Mauldin, Outside the Box at Investors Insight

There are those who sweat over every decision, worrying about how it will affect their lives and investments. Then there is the school of thought that we should focus on the big decisions. I am of the latter school.

85% of investment returns are a result of asset class allocations and only 15% come from actually picking investment within the asset class. Getting the big picture right is critical. In this week’s Outside the Box we look at a very well written essay about the biggest of all question in front of us today. Do we face deflation or inflation?

This OTB is by my good friends and business partners in London, Niels Jensen and his team at Absolute Return Partners. I have worked closely with Niels for years and have found him to be one of the more savvy observers of the markets I know. You can see more of his work at www.arpllp.com and contact them at info@arpllp.com.

John Mauldin, Editor
Outside the Box


Make Sure You Get This One Right

By Niels C. Jensen

"You can’t beat deflation in a credit-based system."

Robert Prechter

Paul VolckerAs investors we are faced with the consequences of our decisions every single day; however, as my old mentor at Goldman Sachs frequently reminded me, in your life time, you won’t have to get more than a handful of key decisions correct – everything else is just noise. One of those defining moments came about in August 1979 when inflation was out of control and global stock markets were being punished. Paul Volcker was handed the keys to the executive office at the Fed. The rest is history.

Now, fast forward to July 2009 and we (and that includes you, dear reader!) are faced with another one of those ‘make or break’ decisions which will effectively determine returns over the next many years. The question is a very simple one:

Are we facing a deflationary spiral or will the monetary and fiscal stimulus ultimately create (hyper) inflation?

Unfortunately, the answer is less straightforward. There is no question that, in a cash based economy, printing money (or ‘quantitative easing’ as it is named these days) is inflationary. But what actually happens when credit is destroyed at a…
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Zero Hedge

European Carmakers Face Perfect Storm

Courtesy of ZeroHedge View original post here.

Authored by Irina Slav via OilPrice.com,

European carmakers are facing what could turn out to be a major crisis cooked up by EU regulators, and it’s all about EVs and emissions. The former are supposed to help solve the problem with the latter, but the likelihood of success is uncertain because there are literally millions of variables: car buyers.

The EU has been enforcing emission ...



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Phil's Favorites

Black Hole Investing

 

Black Hole Investing

Courtesy of John Mauldin, Thoughts from the Frontline 

Scientists say the rules change in a cosmic “black hole” at what astrophysicists call the event horizon. How do they know that? Not by observation, since what happens in there is, by definition, un-seeable. They infer it from the surroundings, which say that the mathematics of the universe as we understand them change at the event horizon.

Or maybe not. One theory says we are all inside a black hole right now. That could possibly explain a few things about central bank policy. ...



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The Technical Traders

Crude Oil Setting Up For A Downside Price Rotation

Courtesy of Technical Traders

Crude Oil has been trading in a fairly narrow range since mid-August – between $52 and $57 ppb.  Our Adaptive Dynamic Learning (ADL) predictive modeling system suggested the downside price move in late July/early August was expected and the current support aligns very well with our ADL predictions of higher price rotation throughout most of September/October.  Please take a minute to review the original research post below :

July 10, 2019: ...



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Insider Scoop

The Street Reacts To Kroger's Q2 With Mixed Takeaways

Courtesy of Benzinga

Kroger Co (NYSE: KR) reported second-quarter results that came in better than expected. The earnings beat may have been overshadowed by management's decision to remove its prior guidance of $400 million in incremental EBIT by fiscal 2021.

Q2 A Mix Of Positives And Negativ...

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Chart School

Dow to 38,000 by 2022

Courtesy of Read the Ticker

President Trump said the Dow would be 10,000 points higher if it was not for the FED. In truth if the Dow breaks to new all time highs the next stop is 38,000 and he may be proven correct. Is there an election on? 

Of course who knows? But lets continue. 

The fundamentals behind this may be:

  • A good deal with China.
  • The FED turning on easy money with further rate cuts (very strange with a market near all time highs). FOMC Sept 17th well tell us more.
  • The above turbo charging stock buy backs.
  • Off shore money running out of foreign equity markets in to US markets (see note1).

Note1: Of course this has happened before, one particular time was just before O...



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Kimble Charting Solutions

Bond Yields Due For Rally After Declining More Than 1987 Stock Crash

Courtesy of Chris Kimble

U.S. Treasury Bond Yields – 2, 5, 10, 30 Year Durations

The past year has seen treasury bond yields decline sharply, yet in an orderly fashion.

This has spurred recession concerns for much of 2019. Needless to say, it’s a confusing time for investors.

In today’s chart of the day, we look at a longer-term view of the 2, 5, 10, and 30-year treasury bond yields.

Short to long term bond yields are all testing 7 to 10-year support levels as momentum is at the lowest levels in a decade.

A yield rally is likely due across the board after a recent decline that was bigger than the stock crash in 1987!

If yields fail to ral...



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Lee's Free Thinking

Nonfarm Payrolls Not Seasonally Adjusted Tell the Real Story - Unspinning Wall Street™

Courtesy of Lee Adler

Not seasonally adjusted nonfarm payrolls, that is, the actual numbers, give us a truer picture of the jobs market than the seasonally adjusted garbage that Wall Street spews.

Friday’s seasonally adjusted nonfarm payrolls jobs headline numbers disappointed investors with slower than expected growth. But was it really that bad?

Here’s How The Street Spun It – Wall Street Journal Modest August Job Growth Shows Economy Expanding, but Slowly

Employers added 130,000 nonfarm jobs, jobless rate held steady at 3.7%

U.S. employment grew only modestly in August, suggesting that a global economic slowdown isn’t driving the U.S. into recession but has dente...



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Digital Currencies

China Crypto Miners Wiped Out By Flood; Bitcoin Hash Rate Hits ATHs

Courtesy of ZeroHedge View original post here.

Last week, a devastating rainstorm in China's Sichuan province triggered mudslides, forcing local hydropower plants and cryptocurrency miners to halt operations, reported CoinDesk.

Torrential rains flooded some parts of Sichuan's mountainous Aba prefecture last Monday, with mudslides seen across 17 counties in the area, according to local government posts on Weibo. 

One of the worst-hit areas was Wenchuan county, ...



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Biotech

The Big Pharma Takeover of Medical Cannabis

Reminder: We are available to chat with Members, comments are found below each post.

 

The Big Pharma Takeover of Medical Cannabis

Courtesy of  , Visual Capitalist

The Big Pharma Takeover of Medical Cannabis

As evidence of cannabis’ many benefits mounts, so does the interest from the global pharmaceutical industry, known as Big Pharma. The entrance of such behemoths will radically transform the cannabis industry—once heavily stigmatized, it is now a potentially game-changing source of growth for countless co...



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Mapping The Market

How IPOs Are Priced

Via Jean Luc 

Funny but probably true:

...

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Members' Corner

Despacito - How to Make Money the Old-Fashioned Way - SLOWLY!

Are you ready to retire?  

For most people, the purpose of investing is to build up enough wealth to allow you to retire.  In general, that's usually enough money to reliably generate a year's worth of your average income, each year into your retirement so that that, plus you Social Security, should be enough to pay your bills without having to draw down on your principle.

Unfortunately, as the last decade has shown us, we can't count on bonds to pay us more than 3% and the average return from the stock market over the past 20 years has been erratic - to say the least - with 4 negative years (2000, 2001, 2002 and 2008) and 14 positives, though mostly in the 10% range on the positives.  A string of losses like we had from 2000-02 could easily wipe out a decades worth of gains.

Still, the stock market has been better over the last 10 (7%) an...



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Promotions

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Here's a free ebook for you to check out! 

Phil has a chapter in a newly-released eBook that we think you’ll enjoy.

In My Top Strategies for 2017, Phil's chapter is Secret Santa’s Inflation Hedges for 2017.

This chapter isn’t about risk or leverage. Phil present a few smart, practical ideas you can use as a hedge against inflation as well as hedging strategies designed to assist you in staying ahead of the markets.

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About Phil:

Philip R. Davis is a founder Phil's Stock World, a stock and options trading site that teaches the art of options trading to newcomers and devises advanced strategies for expert traders...

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About Ilene:

Ilene is editor and affiliate program coordinator for PSW. She manages the site market shadows, archives, more. Contact Ilene to learn about our affiliate and content sharing programs.

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