A Rising Tide Lifts All Ships!

[JBird]

Parsad:

 

What do you believe is a reasonable value for the S&P 500 (or perhaps a range of values), given its present/future earning power and interests rates at 2%?

 

 

 

 

[tyska]

I'm not so sure that is an accurate statement this time. Yes it raises all the ships in the index, as a lot of the money flowing in is going into ETFs and index funds. But it seems a lot of stocks that aren't in the index are being ignored in this rise.

[Parsad]

Parsad:

 

What do you believe is a reasonable value for the S&P 500 (or perhaps a range of values), given its present/future earning power and interests rates at 2%?

 

If the risk premium for stocks (I'm speaking broad market) is priced as it is because interest rates are at 2%, then do you think you are getting a big enough margin of safety?  I don't think so.  You aren't getting enough risk premium in any asset class right now. 

 

My opinion is if you find a cheap stock with enough margin of safety, and you should be assuming a discount rate of no less than 8% or a liquidiation value of 80% of book, then buy that individual investment.  But the broad market, and in fact no single asset class presently, provides that sort of margin of safety. 

 

I have no way to tell you when markets will correct, or even if this market will run another 20-30% before correcting...I just know that I'm having a very hard time finding any idea with an adequate margin of safety other than what I presently own.  And yes, you can go 100% into the ideas you presently own, but remember there is an embedded option in cash and the value of that option increases as the market turns down, with no significant effect if you do not act for a short period of time.  Cheers!

[JBird]

Are you able to (roughly) quantify the intrinsic value of the index?

[Parsad]

Are you able to (roughly) quantify the intrinsic value of the index?

 

The S&P500 earnings are around $105 and it's at 1517...so roughly about 15 times earnings.  Neither cheap, nor expensive historically.  It won't provide you returns larger than growth in GDP and inflation plus dividends.  You also have no boost from interest rates, nor profit margins, which are at historical lows and highs respectively.  Cheers! 

[scorpioncapital]

If interest rates are zero (or negative after inflation), 15x earnings for S&P500 is very cheap. I would expect it to climb much higher. Maybe 30x earnings is more reasonable actually.

[Guest wellmont]

If interest rates are zero (or negative after inflation), 15x earnings for S&P500 is very cheap. I would expect it to climb much higher. Maybe 30x earnings is more reasonable actually.

 

Buffett is valuing stocks as if the long UST bond was yielding 6%. but that's just him. :)

[boilermaker75]

Are you able to (roughly) quantify the intrinsic value of the index?

 

The S&P500 earnings are around $105 and it's at 1517...so roughly about 15 times earnings.  Neither cheap, nor expensive historically.  It won't provide you returns larger than growth in GDP and inflation plus dividends.  You also have no boost from interest rates, nor profit margins, which are at historical lows and highs respectively.  Cheers!

 

Is there a rule of thumb, or maybe it is available somewhere, to approximate the FCF for the SPX from the earnings?

 

 

[Investmentacct]

Are you able to (roughly) quantify the intrinsic value of the index?

 

The S&P500 earnings are around $105 and it's at 1517...so roughly about 15 times earnings.  Neither cheap, nor expensive historically.  It won't provide you returns larger than growth in GDP and inflation plus dividends.  You also have no boost from interest rates, nor profit margins, which are at historical lows and highs respectively.  Cheers!

 

 

 

Is there a rule of thumb, or maybe it is available somewhere, to approximate the FCF for the SPX from the earnings?

 

 

Please check below link and see if it can be useful. You would still have to derive or assume fcf.

http://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/spearn.htm

 

 

[bennycx]

If interest rates are zero (or negative after inflation), 15x earnings for S&P500 is very cheap. I would expect it to climb much higher. Maybe 30x earnings is more reasonable actually.

 

Buffett is valuing stocks as if the long UST bond was yielding 6%. but that's just him. :)

 

Really? Where have you seen that?

[Guest wellmont]

If interest rates are zero (or negative after inflation), 15x earnings for S&P500 is very cheap. I would expect it to climb much higher. Maybe 30x earnings is more reasonable actually.

 

Buffett is valuing stocks as if the long UST bond was yielding 6%. but that's just him. :)

 

Really? Where have you seen that?

 

:)

[stahleyp]

Peter, come on, man!

[bennycx]

Thought he once said that going forward equity markets would yield about 6%. That would mean that there would be no equity premium if he values UST at 6% too...

[Guest wellmont]

he has always used the 30yr ust as his "yardstick" to compare the value of various equities.  He chooses that because equities are long duration instruments and must first beat the bogey of the risk free long duration bond to even be considered for investment. However, in periods of unusually low interest rates, he has used a floor of 6% as his measuring stick. I've read so many different things about Buffy that I can't remember where I read that. But I did. :) My best guess is the John Train Biography, "The Midas Touch", which btw is an often overlooked, comprehensive examination of the OofO.  But here's the greater point. Don't be foolish and mark up the s n p because rates are 3%!

[JBird]

he has always used the 30yr ust as his "yardstick" to compare the value of various equities.  He chooses that because equities are long duration instruments and must first beat the bogey of the risk free long duration bond to even be considered for investment. However, in periods of unusually low interest rates, he has used a floor of 6% as his measuring stick. I've read so many different things about Buffy that I can't remember where I read that. But I did. :) My best guess is the John Train Biography, "The Midas Touch", which btw is an often overlooked, comprehensive examination of the OofO.  But here's the greater point. Don't be foolish and mark up the s n p because rates are 3%!

 

What's your investment hurdle rate?

10% is the figure we quit on -- we don't want to buy equities when the real return we expect is less than 10%, whether interest rates are 6% or 1%. It's arbitrary. 10% is not that great after tax.

Charlie Munger: We're guessing at our future opportunity cost. Warren is guessing that he'll have the opportunity to put capital out at high rates of return, so he's not willing to put it out at less than 10% now. But if we knew interest rates would stay at 1%, we'd change. Our hurdles reflect our estimate of future opportunity costs.]

We could take the $16 billion we have in cash earning 1.5% and invest it in 20-year bonds earning 5% and increase our current earnings a lot, but we're betting that we can find a good place to invest this cash and don't want to take the risk of principal loss of long-term bonds.

Source: BRK Annual Meeting 2003 Tilson Notes

 

Wellmont- Explain if you could your last comment. Do you mean to say the index is overvalued, or should not be priced significantly higher? Would you disagree that interests rates are to financial instruments as gravity is to physics?

 

 

 

 

 

[stahleyp]

thanks peter!

[Guest wellmont]

 

What's your investment hurdle rate?

10% is the figure we quit on -- we don't want to buy equities when the real return we expect is less than 10%, whether interest rates are 6% or 1%. It's arbitrary. 10% is not that great after tax.

Charlie Munger: We're guessing at our future opportunity cost. Warren is guessing that he'll have the opportunity to put capital out at high rates of return, so he's not willing to put it out at less than 10% now. But if we knew interest rates would stay at 1%, we'd change. Our hurdles reflect our estimate of future opportunity costs.]

We could take the $16 billion we have in cash earning 1.5% and invest it in 20-year bonds earning 5% and increase our current earnings a lot, but we're betting that we can find a good place to invest this cash and don't want to take the risk of principal loss of long-term bonds.

Source: BRK Annual Meeting 2003 Tilson Notes

 

Wellmont- Explain if you could your last comment. Do you mean to say the index is overvalued, or should not be priced significantly higher? Would you disagree that interests rates are to financial instruments as gravity is to physics?

 

yeah that sounds about right. 10% after tax. Though back in the day when he was running a smaller book he could find lots of stuff that had a higher yield. I think Greenwald said these days he looks for 16% pretax, something around there. I used to try deconstruct his buys and found that he loves a stock that has a consistent 13%-14% after tax roe with low leverage, a wfc if you will. I think if he could get this kind of stock at around book he'd be a happy camper. If you've ever looked at CLC, clarcor, that would be kind of the model. Though there might be other things about that one that would not pass his test; it is a consistent earner.

 

Of course he does all this stuff in his head. I think the long bond and the 6% floor is just a short hand way for him to compare different stocks to a common benchmark; and to make sure he doesn't pay too high a p/e ratio for stuff he likes. That's a 16-17 times multiple there.

 

I brought this up because increasingly you are going to see people try to justify that the market is attractive still because long term rates are 3%. And I just think that's a mistake because these rates are artificially low right now. they are manipulated. And that with the inflation that is really embedded in this economy on a long term basis, the minimum you would want long term from ust is 6%. So I would just caution, especially if the market moves higher, that you will start to see a rationalization of the value of the market based on low rates.

 

ps: thinking back now...I may have read this idea in one of the old OID transcripts of the brk annual meeting. For a long time he was the only guy transcribing the meeting. He had a monopoly!

[jay21]

I think I remember hearing the 6% somewhere too but can't remember.  I think in Lowenstein's or Hagstrom's book there was a remark that he won't use a discount rate lower than 10%.

[scorpioncapital]

What's to stop interest rates from staying at zero until stocks double from current levels, only then to be raised for them to crash back down? Who wouldn't want to participate in the extraordinary profits from now until that time?

[jay21]

Baupost's view as we enter 2013:  http://www.institutionalinvestorsalpha.com/Article/3152364/Baupost-Navigates-a-Tough-Yet-Still-Profitable-2012.html

 

 

"stock market valuations are increasingly expensive but not extreme"

 

Low corporate yields are a "manifestation of the overall interest rate bubble" or at worst "evidence that investors are accepting insufficient returns for the risks they are taking."

[LC]

Low corporate yields are a "manifestation of the overall interest rate bubble" or at worst "evidence that investors are accepting insufficient returns for the risks they are taking."

This is what Sanjeev is saying in the "how much cash are you holding" thread.

 

My view? We're looking at a sideways market for a while.

[Guest valueInv]

You could also argue that there is a lot of cash waiting in the sidelines that is likely to flow into equities if the market keeps up its momentum.

[Eric50]

When a 16 year old day trader goes on tv and brags about her results, it's probably a sign that the market is ready for a correction.... Money printing can do amazing things!

 

http://www.businessinsider.com/rachel-fox-on-cnbc-2013-2

[Parsad]

You could also argue that there is a lot of cash waiting in the sidelines that is likely to flow into equities if the market keeps up its momentum.

 

Markets may go up because that cash comes in, but from a simple risk premium standpoint, the markets are not providing adequate compensation.  And as I mentioned, I cannot find any single asset class that provides that premium right now...even housing has turned and while not expensive, prices have risen swiftly.  We aren't leaving the markets whole hog or anything, but we have to be very vigilant about the choices we make now.  They have to be very cheap.  You don't want one step forward and three steps back!  Cheers!

[LC]

Are you able to (roughly) quantify the intrinsic value of the index?

 

The S&P500 earnings are around $105 and it's at 1517...so roughly about 15 times earnings.  Neither cheap, nor expensive historically.  It won't provide you returns larger than growth in GDP and inflation plus dividends.  You also have no boost from interest rates, nor profit margins, which are at historical lows and highs respectively.  Cheers!

Sanjeev a question for you...do you attempt to do a rough calculation of the free "call/put option" of cash? It seems to me that this cash option has an inverse relationship with the market P/E. To state the obvious, when prices in the market are high (on average), cash's option is more valuable because the market has more downside.

 

Do you think along these lines at all in terms of holding cash, or do you just say to yourself, "well, everything's expensive, and I wouldn't buy some of what I already own at these prices...so let me sell a bit and wait until things get cheaper"?