About Me

Retired chief investment officer and former NYSE firm partner with 50 plus years experience in field as analyst / economist, portfolio manager / trader, and CIO who has superb track record with multi $billion equities and fixed income portfolios. Advanced degrees, CFA. Having done much professional writing as a young guy, I now have a cryptic style. 40 years down on and around The Street confirms: CAVEAT EMPTOR IN SPADES !!!

Wednesday, March 24, 2010

Stock Market -- Valuation Benchmarks

Last of a three part post on market fundamentals.

The SP 500 Market Tracker based on 12 months eps through

3/10 sits at 1060. The market is currently trading at a 10%

premium to the Tracker. The spread is not onerous.

With rebounding earnings and rising estimates, the market is

discounting continuing strong net per share performance into the

third Q of 2010. Again, not unusual.

The Tracker, based on a full year consensus estimate of a touch

over $78 per share, would fetch a value 1290 for the SP 500 by

late in 2010. Since advance indicators point to sharply rising

recovery eps into Q 3, this is probably a reasonable enough


So far, investors are showing no concern about the issues of

exiting accomodative monetary policy and strong fiscal stimulus.

Both issues could arise as concerns later in the year.

The Market Tracker based on super long term trend earnings

gives a "500"value of 1155 for 2010 and 1230 for 2011. So, for

investors with a longer term time horizon, the market is now

fairly valued. This means that the chances for sizable excess

returns depends entirely on continued strong earnings gains and

a moderate level of inflation (not in excess of 3.5% per).

I also use a simple dividend discount valuation model and a

kindred p/e assessment model based earnings plowback. The

dividend discount model reveals that investors are expecting a

cyclical recovery of the dividend and that players are also

factoring in earnings / dividend growth of between 7.5 -8.0%

long term. From an economic perspective, this would imply

top line growth of 6.0 - 6.5% plus further profit margin

improvement. That would represent a tall order if the USA was

the exclusive focus. So, implicit in investor's minds are continued

aggressive balance sheet management such as share buy-backs,

and the benefits of increasing SP 500 exposure to faster growing

emerging and developing economies with lower cost structures.

Clearly, investors do not have humble expectations.

Over the past 20 years, companies have allowed dividend

payout ratios to decline and have increased the ratio of earnings

plowed back into the business. Return on Equity % x earns.

plowback rate = implied internal growth. Excluding the recent

recession years the formula would run as follows: 15% x 65% =

9.75%. That would imply a p/e ratio over 20x trend eps.

Investors, seeing that few companies can grow by over 10%

a year, have not bought into the corporate strategy since the

bubble days of 1996 - 2000. And, they have been correct to be

more conservative. In fact, I suspect that earnings and market

performance for the SP 500 would have been more stable had

companies payed out more in dividends than they have.

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