Sunday 14 November 2010

Why I'm with Warren Buffett on bonds versus equities

Follow the herd or follow Warren Buffett? That sounds like it should be a pretty simple choice for most investors given the average investor's consistent ability to buy and sell at the wrong time and the sage of Omaha's ranking as one of the world's richest men.



By Tom Stevenson 6:15PM BST 09 Oct 2010
Curious then that Mr Buffett is doing a passable imitation of Cassandra – she who was cursed so that she could foretell the future but no one would ever believe her.
Here's Buffett, speaking last week to Fortune magazine's Most Powerful Women Summit: "It's quite clear that stocks are cheaper than bonds. I can't imagine anyone having bonds in their portfolio when they can have equities ... but people do because they lack the confidence."
And here's what everyone else is doing. According to Morgan Stanley, the speed of inflows to bond funds is even greater than retail inflows into equity funds at the height of the technology bubble in 2000 – $410bn (£256bn) in the 12 months to April 2010 in the US versus $340bn into equities in the year to September 2000.
RELATED ARTICLES
Over here, too, investors can't get enough fixed income. According to the Investment Management Association, net sales of global bonds and corporate bonds both exceeded £600m during August. Only absolute return funds were anywhere close to these inflows. The staple British equity fund sector, UK All Companies, saw £291m of redemptions and even the previously popular Asia ex-Japan sector raised a paltry £22m.
So, is this a bubble waiting to burst or a logical investment choice in a deflationary world where interest rates could stay lower for longer as governments adopt more desperate strategies to prevent another slump?
The case for bond prices staying high has received a boost in recent weeks as speculation has grown that the US government is contemplating a second round of quantitative easing. Printing yet more money to buy bonds creates a buyer of last resort and would underpin the price of Treasuries even at today's elevated levels.
Indeed, the talk on Wall Street has turned to a measure the US government has not employed since the Second World War when a target yield for government securities was set with the implied promise that the authorities would buy up whatever they needed to keep the cost of money low.
Ben Bernanke, the Fed chairman, referred to this policy in his famous "Helicopter Ben" speech of 2002 when he reminded financial markets of the US government's ultimate weapon in the fight against deflation – the printing press. It really is no wonder that the price of gold is on a tear.
For a few reasons, however, I'm not convinced that the theoretical possibility that interest rates could go yet lower à la Japan makes a good argument for buying bonds at today's levels.
First, to return to fund flows, extremes of buying have in the past been a very good contrarian indicator of future performance. Equity flows represented around 4pc of total assets in 2000 just as the bubble was bursting. At the same time, there were very significant outflows from bond funds just ahead of a strong bond market rally.
My second reason for caution is illustrated by the chart, which shows how little reward investors are receiving for lending money to the US government (and the UK, German or Japanese governments for that matter). Accepting this kind of yield makes sense only if you believe the US economy is fatally wounded and that the dragon of inflation has been slain. I don't believe in either thesis.
History shows very clearly that investing in bonds when the starting yield is this low has resulted in well-below-average returns if and when rates start to rise. Between 1941 and 1981, when interest rates last rose for an extended period, the total return from bonds was two and a half times lower when the starting point was a yield of under 3pc than when it started above this level. Investing when yields are low stacks the odds against you.
My final reason for caution is that there is no need to put all your eggs in the bond basket. Around a quarter of FTSE 100 shares are yielding more than 4pc while the income from gilts is less than 3pc. More income and the potential for it to rise over time too. I'm with Warren on this one.
Tom Stevenson is an investment director at Fidelity Investment Managers. The views expressed are his own.
Posted by at No comments:
Labels: , , ,

The ultimate determinant of eventual returns is the price you pay at the outset. History shows that the best way to invest is against the tide but not blindly so.

For most, equities are still a step too far


A feature of investment markets this year has been the so-called risk-on, risk-off trade whereby investors have swung between an appetite for more risky assets like shares and commodities and a desire to play it safe in the perceived calm havens of government bonds and cash.



By Tom Stevenson, on The Markets
8:35PM GMT 13 Nov 2010





This jumpiness is part of a bigger trend away from the certainties of the pre-2000 equity bull market towards a foggier investment landscape in which investors are scrabbling around for three sometimes contradictory outcomes: capital security in a volatile world; a decent income in an environment of near-zero interest rates; and growth against a backdrop of deleverage and austerity.
The chart illustrates how much the investment world has changed over the past decade. In 2000 there was only one game in town. Around £8 of every £10 invested in UK mutual funds by private investors went into equities, with about £1 into bonds and the same into balanced funds.
Fast forward nine years to 2009 and a very different picture emerges. Last year, less than a third of net retail sales of UK funds was in funds investing in the stock market. A larger proportion went into bonds while much of the remainder went into absolute return and cautious managed funds. This is not just a UK picture. Figures compiled by Citigroup show that inflows into equity funds have been nothing to write home about across Europe (in fact they are negative pretty much everywhere outside the UK) while bond funds continue to attract money despite increasing fears in the eurozone periphery. The big winner has been balanced funds.
RELATED ARTICLES
What this tells us, I think, is that investors are being forced out of cash and into riskier assets by persistently low interest rate policies but, despite the return to form of stock markets over the past 18 months, the pain of the "lost decade" and recent volatility mean that for most people equities remain a step too far.
The money that is going in to equities is largely chasing the perceived growth offered by emerging markets, which confirms the contradictory thinking driving asset allocation at the moment. Investors' desire for safety, income and growth all at the same time smacks of wanting their cake and eating it. This is leading to some pretty indiscriminate investment with not a lot of attention to which assets currently offer the best value.
There are some good technical reasons why investment flows should have shifted towards less risky assets. The matching of assets to liabilities by pension funds and the ageing of the average member of pension schemes are part of the story – as are greater capital requirements in the insurance sector. But something else less logical and more worrying seems to be going on. Investors yet again appear to be chasing past performance in a rose-tinted piece of extrapolation which assumes that last year's winners will inevitably be next year's too.
In 2000 the best-performing asset classes over the preceding five years in the UK were residential property, European equities and hedge funds. It is perhaps unsurprising that fund flows should have been so skewed. Jump to 2009 and the best-performing assets were gold, corporate bonds, gilts, German bunds and US Treasuries. Guess where the money is now going.
We know what happened to those caught up in the equity mania 10 years ago, so it is not unreasonable to ask what the returns will be 10 years hence on all the money currently pouring into precious metals, government bonds and emerging market equities.
History shows that the best way to invest is against the tide but not blindly so. Fund flows are only a part of the story because the ultimate determinant of eventual returns is the price you pay at the outset. In the case of emerging market equities, the multiple of earnings on which the average share trades is bang in line with global markets generally, according to Morgan Stanley's calculations.
When Japanese stocks peaked in 1989 it was at three times the global average, while technology stocks in 2000 were twice as expensive. Equities, emerging and developed, are much better value than government bonds – which is just what the fund flows are telling us.
Tom Stevenson is an investment director at Fidelity Investment Managers. The views expressed are his own


http://www.telegraph.co.uk/finance/comment/tom-stevenson/8130470/For-most-equities-are-still-a-step-too-far.html


Main Points:
What this tells us, I think, is that investors are being forced out of cash and into riskier assets by persistently low interest rate policies but, despite the return to form of stock markets over the past 18 months, the pain of the "lost decade" and recent volatility mean that for most people equities remain a step too far.


Investors yet again appear to be chasing past performance in a rose-tinted piece of extrapolation which assumes that last year's winners will inevitably be next year's too.


In 2000 the best-performing asset classes over the preceding five years in the UK were residential property, European equities and hedge funds. It is perhaps unsurprising that fund flows should have been so skewed. Jump to 2009 and the best-performing assets were gold, corporate bonds, gilts, German bunds and US Treasuries. Guess where the money is now going.


History shows that the best way to invest is against the tide but not blindly so. Fund flows are only a part of the story because the ultimate determinant of eventual returns is the price you pay at the outset. 
Posted by at No comments:
Labels: , ,

Saturday 13 November 2010

Kossan



Date announced 26/08/2010
Quarter 30/06/2010 Qtr 2
FYE 31/12/2010

STOCK Kossan
C0DE  7153 

Price $ 3.13 Curr. PE (ttm-Eps) 5.02 Curr. DY 1.64%
LFY Div 5.13 DPO ratio 12%
ROE 24.8% PBT Margin 14.1% PAT Margin 11.7%

Rec. qRev 256495 q-q % chg -2% y-y% chq 30%
Rec qPbt 36253 q-q % chg -7% y-y% chq 116%
Rec. qEps 18.77 q-q % chg -1% y-y% chq 123%
ttm-Eps 62.38 q-q % chg 20% y-y% chq 70%

Using VERY CONSERVATIVE ESTIMATES:
EPS GR 5% Avg.H PE 7.00 Avg. L PE 5.00
Forecast High Pr 5.57 Forecast Low Pr 2.95 Recent Severe Low Pr 2.95
Current price is at Lower 1/3 of valuation zone.

RISK: Upside 93% Downside 7%
One Year Appreciation Potential 16% Avg. yield 3%
Avg. Total Annual Potential Return (over next 5 years) 19%

CPE/SPE 0.84 P/NTA 1.24 NTA 2.52 SPE 6.00 Rational Pr 3.74



Decision:
Already Owned: Buy Hold Sell Filed Review (future acq): Filed Discard: Filed
Guide: Valuation zones Lower 1/3 Buy Mid. 1/3 Maybe Upper 1/3 Sell

Aim:
To Buy a bargain: Buy at Lower 1/3 of Valuation Zone
To Minimise risk of Loss: Buy when risk is low i.e UPSIDE GAIN > 75% OR DOWNSIDE RISK <25%
To Double every 5 years: Seek for POTENTIAL RETURN of > 15%/yr.
To Prevent Loss: Sell immediately when fundamentals deteriorate
To Maximise Gain & Reduce Loss: Sell when CPE/SPE > 1.5, when in Upper 1/3 of Valuation Zone & Returns < 15%/yr
Posted by at No comments:
Labels: ,

*Hartalega



Date announced 11-Sep-10
Quarter 30/09/2010 Qtr 2
FYE 31/03/2011

STOCK Hartalega C0DE 5168
Price $ 5.49 Curr. PE (ttm-Eps) 11.59 Curr. DY 2.43%
LFY Div 13.33 DPO ratio 34%
ROE 40.8% PBT Margin 33.1% PAT Margin 25.6%

Rec. qRev 184312 q-q % chg 8% y-y% chq 37%
Rec qPbt 61018 q-q % chg 13% y-y% chq 48%
Rec. qEps 12.96 q-q % chg 14% y-y% chq 42%
ttm-Eps 47.37 q-q % chg 9% y-y% chq 53%

Using VERY CONSERVATIVE ESTIMATES:
EPS GR 5% Avg.H PE 12.00 Avg. L PE 10.00
Forecast High Pr 7.25 Forecast Low Pr 4.13 Recent Severe Low Pr 4.13
Current price is at Middle 1/3 of valuation zone.

RISK: Upside 56% Downside 44%
One Year Appreciation Potential 6% Avg. yield 4%
Avg. Total Annual Potential Return (over next 5 years) 10%

CPE/SPE 1.05 P/NTA 4.73 NTA 1.16 SPE 11.00 Rational Pr 5.21



Decision:
Already Owned: Buy Hold Sell Filed; Review (future acq): Filed; Discard: Filed
Guide: Valuation zones Lower 1/3 Buy; Mid. 1/3 Maybe; Upper 1/3 Sell

Aim:
To Buy a bargain: Buy at Lower 1/3 of Valuation Zone
To Minimise risk of Loss: Buy when risk is low i.e UPSIDE GAIN > 75% OR DOWNSIDE RISK <25%
To Double every 5 years: Seek for POTENTIAL RETURN of > 15%/yr.
To Prevent Loss: Sell immediately when fundamentals deteriorate
To Maximise Gain & Reduce Loss: Sell when CPE/SPE > 1.5, when in Upper 1/3 of Valuation Zone & Returns < 15%/yr


----

HHB 2Q 2011Notes_101109 (2).pdf

Commentary on Prospects and Targets

Our Group’s products are sold to the Health Care Industry. Glove consumption is inelastic in the medical environment because the usage of glove is mandatory for disease control. Our nitrile synthetic glove was well accepted by the end users due to its high quality and elastic properties that mimic that of a natural rubber glove. Our protein free and competitive priced nitrile glove has made it more affordable for the acute health care industry to continue switching from the natural rubber to our synthetic nitrile glove to avoid the protein allergy problem.

We have commissioned 2 more new advanced high capacity glove production lines for the current quarter ended 30 September 2010, the balance of the 4 lines from Plant 5 will be fully ready by January 2011. We will continue to take advantage of the Demand Growth for nitrile gloves due to health care reform and the expansion in usage of nitrile gloves in the food industry. Our company is well positioned with the competitive advantage delivered by our high output production lines to compete in what is expected to be a challenging and competitive market as more players will emerge in the synthetic nitrile glove sector. While the weakening of USD continues deliver pressure on product pricing.

Despite that, the Board of Directors is optimistic that the Group will achieve the internal target growth for both sales revenue and net profit for the financial year ending 31 March 2011.
Posted by at No comments:
Labels: ,

Topglove



Date announced 6-Oct-10
Quarter 31/08/2010 Qtr 4
FYE 31/08/2010

STOCK TOPGLOV
C0DE  7113 

Price $ 5.77 Curr. PE (ttm-Eps) 14.18 Curr. DY 2.77%
LFY Div 16.00 DPO ratio 39%
ROE 22.5% PBT Margin 7.8% PAT Margin 8.3%

Rec. qRev 541386 q-q % chg -3% y-y% chq 27%
Rec qPbt 42166 q-q % chg -49% y-y% chq -47%
Rec. qEps 7.30 q-q % chg -31% y-y% chq -24%
ttm-Eps 40.70 q-q % chg -5% y-y% chq 42%

Using VERY CONSERVATIVE ESTIMATES:
EPS GR 5% Avg.H PE 13.00 Avg. L PE 9.00
Forecast High Pr 6.75 Forecast Low Pr 4.98 Recent Severe Low Pr 4.98
Current price is at Middle 1/3 of valuation zone.

RISK: Upside 55% Downside 45%
One Year Appreciation Potential 3% Avg. yield 4%
Avg. Total Annual Potential Return (over next 5 years) 7%

CPE/SPE 1.29 P/NTA 3.19 NTA 1.81 SPE 11.00 Rational Pr 4.48



Decision:
Already Owned: Buy Hold Sell Filed; Review (future acq): Filed; Discard: Filed
Guide: Valuation zones Lower 1/3 Buy; Mid. 1/3 Maybe; Upper 1/3 Sell

Aim:
To Buy a bargain: Buy at Lower 1/3 of Valuation Zone
To Minimise risk of Loss: Buy when risk is low i.e UPSIDE GAIN > 75% OR DOWNSIDE RISK <25%
To Double every 5 years: Seek for POTENTIAL RETURN of > 15%/yr.
To Prevent Loss: Sell immediately when fundamentals deteriorate
To Maximise Gain & Reduce Loss: Sell when CPE/SPE > 1.5, when in Upper 1/3 of Valuation Zone & Returns < 15%/yr
Posted by at No comments:
Labels: ,

The coming flight to quality stocks (Jeremy Grantham)

The coming flight to quality stocks
Posted by Scott Cendrowski, reporter
October 27, 2010 1:40 pm

Leave it to Jeremy Grantham to blast Fed Chairman Ben Bernanke and former chairman Alan Greenspan in a rightfully scary missive titled "Night of the Living Fed."



Jeremy Grantham, the institutional money manager in Boston who oversees nearly $100 billion, has been as critical of the Fed's interest rate policies over the past 15 years as he has been adept at spotting bubbles fueled by the low rates. He warned clients of tech stocks more than a decade ago and more recently called a worldwide asset bubble before the meltdown in 2008. (Though he's labeled a perma-bear, Grantham pounces on opportunities: on March 10, 2009, at the market's lows, he encouraged clients to load up on stocks in a note titled "Reinvesting When Terrified.")

His latest quarterly note reminds investors how dangerous it is for Bernanke and Co. to rely on ultra-low interest rates, and the resulting cheap debt, to promote economic growth. "My heretical view is that debt doesn't matter all that much to long-term growth rates," he writes. "In the real world, growth depends on real factors: the quality and quantity of education, work ethic, population profile, the quality and quantity of existing plant and equipment, business organization, the quality of public leadership (especially from the Fed in the U.S.), and the quality (not quantity) of existing regulations and the degree of enforcement."

A graph of total debt compared to U.S. GDP growth drives home the point: as the U.S. tripled its debt compared to GDP in the past three decades, GDP growth slowed to 2.4% from its 100-year average of 3.4%.

Read Grantham's entire note below (and we really encourage you to do so, even if it takes the better part of an afternoon). The most sobering section must be the effect that near zero percent interest rates has on retirees in the U.S.

"When rates are artificially low, income is moved away from savers, or holders of government and other debt, toward borrowers," Grantham writes. "Today, this means less income for retirees and near-retirees with conservative portfolios, and more profit opportunities for the financial industry; hedge funds can leverage cheaply and banks can borrow from the government and lend out at higher prices or even, perish the thought, pay out higher bonuses. This is the problem: there are more retirees and near-retirees now than ever before, and they tend to consume all of their investment income."

Flight to quality

Since Grantham is foremost a stock investor, we'll let you read his criticisms and instead highlight what he thinks it means for stocks. Grantham's takeaway: don't fight the Fed.

Stocks, which are overvalued by historical standards, can still run up 20% or more, he says.

Year three of a presidential cycle is typically a good time for stocks. Since FDR's presidency, some 19 cycles have passed with only one bear market. That, coupled with low short-term interest rates, leads Grantham to affix 50/50 odds on the S&P 500 Index reaching 1,400 or 1,500 in the next year.

"There is also the definite possibility that we could slide back into a double dip, so we may get lucky and have a chance to buy cheaper stocks," he writes. "But probably not yet. And, of course, if we get up to 1400 or 1500 on the S&P, we once again face the consequences of a badly overpriced market and overextended risk taking with six of my predicted seven lean years still ahead."

To cope with seven lean years (more here), Grantham still proselytizes high-quality stocks: the 25% of companies in the S&P 500 with low-debt and high, stable returns.

"For good short-term momentum players, it may be heaven once again," he writes. "Being (still) British, this is likely to be my nth opportunity to show a stiff upper lip." And it may be easier even for average investors, he observes, to buy high-quality blue chips because they are getting "so cheap" relative to the market.

Recently, in the largest stock rally since 1932, Grantham often notes, high-quality blue chips have trailed the speculative, debt-laden companies within the S&P 500. He writes that chances are one in three that, come another rally in the next year, high-quality stocks will join in. "….Quality stocks are so cheap that they will 'unexpectedly' hang in," he writes.

JG Letter Night of Living Fed 3Q 2010

http://finance.fortune.cnn.com/2010/10/27/the-coming-flight-to-quality-stocks/
Posted by at No comments:
Labels: ,

Herd mentality costs investors dear



Herd mentality costs investors dear
Thousands of investors have missed out on the recent FTSE gains because they shunned equities.



Investors that follow the herd lose out 
By Paul Farrow, Personal finance editor 6:01AM GMT 13 Nov 2010
Comments
Investors' habit of following the herd has cost them hundreds of millions of pounds in lost returns as the FTSE 100 continues to climb.
The blue chip index has returned more than 50pc over the past 20 months. Yet hundreds of thousands of investors will have missed out on those gains because they were busily withdrawing money from equity funds as the market fell.
Go back to the start of 2009 and investor confidence was at an all-time low after the banking crisis. The FTSE 100 had fallen sharply and investors sought sanctuary in bond funds and absolute return funds (which aim to deliver positive returns in falling markets). During the first three months of 2009 net sales of corporate bonds were £4bn, compared with just £200m in equities, official figures reveal.
RELATED ARTICLES
The timing of their run to safety couldn't have been worse. Since January 2009 the FTSE 100 has risen by 52pc – by comparison, the average corporate bond fund has returned 28pc, the average absolute return fund 9pc and the average cautious managed fund (another big seller) 23pc. The bestselling absolute return fund, BlackRock Absolute Alpha, is up by just 4pc – it is not designed to deliver bumper returns in a bull run.
Alan Steel of Alan Steel Asset Management asked: "Why is it the herd always piles into the wrong sector or investment at the wrong time?" One reason for a herd approach is that investors follow performance and this frequently sees them buy at the top of the market and sell at the bottom.
In 2000, for example, investors waded into technology funds when they should have been avoiding the sector. Those who bought at the peak soon saw the value of funds more than halve.
The 2006 commercial property phenomenon was another classic example. Many investors bought the funds as valuations reached unsustainable heights; the ensuing credit crisis triggered sharp falls in fund values.
Mr Steel said contrarian investors were often mocked, even though they can be proved right. "In February 2009 I suggested that stock markets were likely to rise imminently. I received comments from people who, anonymously, suggested I should be locked up or burned at the stake," he said.
"As doomsters on the telly continue the constant bad news with predictions that never come true, such as the double dip that's supposed to happen or the British economy that's supposed to collapse, I think it is better to share what's actually happened since the terrible days early in 2009. And it's good news."
Mr Steel is feeling smug with some justification, as the funds he recommended have soared. Neptune Russia and Greater Russia are up by 150pc, First State's Global Emerging Market fund has risen by 140pc, J P Morgan Natural Resources is up by 120pc and M & G Global Basics by 80pc, he says.
So what now? Investors will be chewing the cud, wondering whether they are at risk of buying shares at the wrong time again, given the FTSE 100's lofty rise to a 28-month high.
Mr Steel said he was expecting a correction, but insisted that investors should not avoid buying shares for fear of a setback. "We've been hoping for a little correction just to get a bit of common sense back into expectations for equities and it may still happen over the next couple of weeks. But we believe this is a time to embrace equities, not only in emerging markets and the Far East but in other places including Britain and the US," he said.
John Chatfeild-Roberts of Jupiter said the easy money made off the back of bombed-out shares had been made. But he believes that, as long as investors are selective about the shares and funds they buy, equities are still the asset of choice. UK funds he owns are Fidelity Special Situations, Invesco Perpetual Income, M & G Recovery and Jupiter Special Situations. "Government bonds are unlikely to provide a real return in the medium term, but many of the blue chips have not taken part in the rally and remain cheap," he said.
With clouds still hovering over the British economy, FTSE stocks that derive a significant chunk of their earnings from overseas have also been getting attention from fund managers.
"We are keen on UK companies with overseas exposure and the ability to raise profit margins from current levels," said Colin McLean at SVM. "British industrial companies such as IMI and Croda are still underrated relative to international peers, and could attract bids. Other leading global brands listed in the UK include British Airways and Burberry."
He added: "The risks in the stock market are in businesses more exposed to the British economy; consumer sectors and banks. Investors should focus on assets that have some protection against a weak pound and a sluggish UK economy."
Robert Burdett of Thames River agreed that the easy money in the UK had been made, but he still believes that shares offer good value and are cheap relative to most other asset classes. "Over a five-year-plus view I would not hesitate in putting equities first above bonds, property and other major assets," he said. Mr Burdett's favoured UK funds include Standard Life UK Opportunities, JOHCM UK Growth and Artemis UK Special Situations.
Many advisers reckon that UK equity income funds, which have not fared as well in the past three years, are also worth considering. Dividends are making a comeback after a disastrous two years and could be a useful contrarian bet.
Adrian Lowcock of Bestinvest said: "With stock markets reaching recent highs, a long-term approach to investing would be through companies with good cash flow, many of which pay good dividends. This is a long-term investment strategy and will provide some short-term protection should markets retreat.
Posted by at No comments:
Labels: ,

Market PE and Ten-Year Forward Real Returns (S&P 500 Index)

“It’s time in the market, not timing the market that counts."

This gives rise to the all-important question: does one’s entry level into the market, i.e. the valuation of the market at the time of investing, make a significant difference to subsequent investment returns? 




This analysis strongly confirms the downward trend of the average ten-year forward real returns from the cheapest grouping (PEs of less than six) to the most expensive grouping (PEs of more than 21).

The second study also shows that any investment at PEs of less than 12 always had positive ten-year real returns, while investments at PE ratios of 12 and higher experienced negative real returns at some stage. 

A third observation from this analysis is, interestingly, that the ten-year forward real returns of investments made at PEs between 12 and 17 had the biggest spread between minimum and maximum returns and were therefore more volatile and less predictable. 

It is easy to understand why Grantham came to the conclusion that “the best case for caution and bearishness is value, which is a weak predictor of one-year returns, but a dynamic predictor of longer-term returns”.

http://investmentpostcards.wordpress.com/2007/06/05/us-equity-returns-what-to-expect/
Posted by at No comments:
Labels: , , , ,

Rational Value: Your Key to Contentment (Ellis Traub)

Rational Value: Your Key to Contentment

May 8th, 2009
Many of my posts have referred to rational value. And I’ve been remiss in not making a special effort to define this term for my readers—one I coined several years ago to try to help investors like us keep their minds on what’s important. The significance of this term is that it can keep our feet on the ground when the market is overvalued, and keep our head in the clouds when it’s in the tank. And, on an ongoing basis tell it will us what the reasonable (rational) value of our shares would be.
Rational Value Defined
Simply defined, Rational Value is the approximate value of a share of stock were it to be selling at its rational price—the price investors would pay for it if it were selling at its historical average multiple or “signature PE.”
If you have calculated either the Historical Value Ratio (HVR) or the Relative Value (RV), the simplest way to determine its Rational Price is to divide the current market price by either of those figures.
If, for example, the HVR or RV of XYZ company is 50%, and the current market price were $50, dividing the $50 by .50 would give you a rational value of $100—the price one would pay for it if one were “rational.” So, as you can see, the rational value is the value of your shares when the RV or HVR are 100%.
For those who have not been exposed to either RV or HVR, let me explain and define these terms for you.
Relative Value or Historical Value Ratio
Our methodology is based upon a very basic premise: “Real” investors—those who own stock as part owners of the businesses that have issued it—attach a value to their ownership that is related to the ability of those businesses to earn money and to grow. That relationship between a company’s earnings and the market price of the stock is recognized as the Price Earnings Ratio (PE). [For a more detailed discussion of this relationship and its importance, read "What's a PE and What's it To Me?"] For our purposes here, let’s define the PE simply as the unit price for one dollar’s worth of a company’s earnings.
You can tell if a gallon of gas is cheap or expensive because its price is under or over a “typical” or average price that’s fairly familiar to you. And an investor similarly knows if a share of stock is overpriced or inexpensive, based up what it has typically sold for. Because the price of the shares of a company will vary over time and the PE is relatively stable, we use the multiple of earnings it has sold for—its PE—rather than the price, itself, to judge its value. And that determination is what the HVR or RV provides us.
The RV is a comparison of the current PE with the historical (five-year) average and is calculated by dividing the current PE by that historical average PE. The HVR is similar, except it’s derived by dividing the current PE by the historical (ten-year) median. [The median is the middle value in a series of values and is not unduly influenced by wide swings or outliers.]
That mid-point, however you calculate it, becomes the stock’s “signature PE”—the multiple at which the stock would sell if it were purchased strictly for its earnings performance. By taking the longer term view, we effectively cancel out the short-term ups and downs of the price that are caused by the herd’s whims and guesses. These, of course, are measured—as if we care—by the amplitude of the distance betwen the high and low PEs either side of that mid-point.
It’s the amplitude of the swings either side of that signature PE or mid-point that measure the “rationality” of the price. If everyone were rational; i.e., if everyone were to buy or sell the stock based upon its underlying company’s earnings, the price would be “rational” all the time. However, in times like these, when “irrational despair” prompts the herd to panic and sell its shares, the price of those shares becomes irrationally low. Of course, in the opposite extreme, when the public is “irrationally exuberant,” as former Fed Chairman, Alan Greenspan labled the condition, the prices were irrationally high!
Therefore, the rational price of a share of stock is simply the price that would be paid for the stock if everyone were rational. And, the beauty of this concept is, because the “rational value” is derived from the midpoint of sales and purchases over time, it’s easy to be confident that we will see the price return to that point—and probably overshoot it—when those investors come back to their senses.
Application of Rational Value
The normal cycles in the stock market are caused, in large measure, by the herd’s overshooting in both directions. But, don’t knock it. That’s what makes for the bargains from time to time. It also provides us with an additional opportunity to improve our portfolios’ performances by replacing a position, when it’s so overvalued you can no longer expect a reasonable return on it over the next five years, with one of as good quality but which has a better potential for return.
To sum up, the “rational value,” therefore, is a value of a your holdings to which you can count on your shares returning when the herd comes back to its senses. And that’s the only value you need be concerned about as you perform your portfolio management tasks.
So, sit back, relax, and wait for that to happen. It may take a little longer than usual because the herd is more demoralized than usual; but the value is there, and it will continue to be. Someday soon, we’ll start to see the more intelligent of investors, satisfied that the market has shaken out the last few of its gamblers, backing up the truck and starting to cart off those bargains. And, not long after that, the herd will thunder back, wanting to get on the bandwagon.

Posted by at No comments:
Labels: , ,

What’s Wrong with the Stock Market?

What’s Wrong with the Stock Market?
April 14th, 2009

The problem with the stock market started back before the end of the 18th century—in 1792 as a matter of fact. This was when the stock market as we know it was born under a tree in lower Manhattan. It was there and then that those who first bought and sold stocks as a business got together and formed what became the New York Stock Exchange. From those beginnings, an industry was born that has grown to be one of the most powerful and financially influential in the world.

Transaction-based Compensation – the Wrong Dynamic
Actually, the problem arose from the fact that these people made their money not from any appreciation in the value of the investments they bought and sold but rather from just putting buyers and sellers of those shares together. They profited from the transaction itself. To this day, the majority of brokers receive their compensation as a result of the purchase or sale. It makes no financial difference to them whether their customer gains or loses.

I don’t mean to imply that, just because these people fill a need and are compensated for doing so, they’re bad people. Certainly the existence of this industry is what makes the ownership of stock feasible for the average person. It’s responsible for elevating common stock to the level of liquidity that allows us to own it without fear of being stuck with it when or if we choose to sell it. And it certainly makes it much easier for us to buy those shares when we wish to. If we’re interested in putting our money to work for us in what is arguably the most lucrative manner possible for the least amount of risk, we can’t get along without this industry. But, the difference in perception and fact between what a broker does or is qualified to do and what the uninitiated think he or she is qualified to do is a major source of the problem.

In the beginning, the whole idea of shares was just that: sharing in the fortunes of an enterprise. Where it might be difficult for a company or individual to come up with enough money to finance all that was necessary alone, sharing the business with others in a fashion that limited their liability and exposure to only the amount of money invested was a great way to obtain the necessary funds. Anyone who wanted to participate in a business—sharing both the rewards and the risks—would buy shares and hold them as legal documents that vouched for their entitlement to a proportionate share in the fruits of that enterprise’s operations. Originally, therefore, folks bought shares because they thought the business would be profitable one and they wanted a piece of the action.

The formation of a ready market for stocks, while it performed a very useful service in terms of liquidity and convenience, had a serious side effect. So easy was it to trade that the perception of what a share of stock really was became obscured, giving way to the notion that the stock, like currency, had some intrinsic value that could vary for reasons other than the success or failure of the underlying enterprise.

Easy Trading changed the Nature of the Market
Moreover, the ability to manipulate the perceived value of those shares erected a persistent barrier between those that manipulated it and those that didn’t. It was de rigueur for unscrupulous traders to spread rumors appealing to the fear of the uninitiated, driving down the price of a certain stock, and furnishing an opportunity to pick up a large position at that favorable price. And then it was an equally simple process for those same individuals to spread favorable rumors that appealed to the greedy, drove up the price, and resulted in a great selling opportunity for those who then owned it. Not until well into the 20th century, after the devastating crash of 1929, was there a real effort to address that issue legislatively and make such activities illegal.

However, there was—and is—no way to legislate the greed and fear out of the stock market. Those are still its basic drivers. In fact, as recently as within the last decade, a young kid from New Jersey managed to make nearly a million dollars when he flooded the Internet with glowing stories about a penny stock he had selected for his venture. Unwitting investors bid up the price of the stock with no more to go on than his fiction; and he made a killing.

Disconnect Between Value and Price Creates Bubbles and Busts
The very same dynamics of greed and fear were responsible for an even more spectacular event that impacted millions of shareholders. The appeal of the dot.coms, most of them with no visible means of support—and the technology companies that depended upon them for their burgeoning customer base—inflated one of history’s biggest bubbles. Investors, eager to make a killing, continued to bid up the price of the stock in those companies with no regard for or even any understanding of the factors that comprised their underlying value. This was what the Street refers to as the Greater Fool Theory: “I may be a fool to buy this stock at this price; but I’ll find a greater fool to take it off my hands for more than I paid for it!”

The market of course collapsed when those companies—like Wiley Coyote racing off a cliff only to discover he had nothing under him—learned the hard way that a company had to earn money to live. The extent of that collapse went well beyond rational concerns about the profitability of the affected companies, being exacerbated in large measure by irrational fears growing out of the September 11th, 2001, attack on New York’s World Trade Center and our country’s bellicose activities following that tragedy.

http://www.financialiteracy.us/wordpress/articles/what%E2%80%99s-wrong-with-the-stock-market/
Posted by at 1 comment:
Labels: , , , ,
Subscribe to: Posts (Atom)