>>I don't know Wayne, I used to be in your camp, but when people like Abby
Joseph Cohen, who was bearish in 1990 and Byron Wien, who's no Polyanna,
aren't particularly bearish, I wonder if maybe the market as a whole is
in fact not too high? If you take away the best performers of the S&P
500 I'm not sure that p/e s as a whole are totally outrageous. P/Es of
small caps aren't that high, are they?<<
To the best of my understanding they are using what I would call snapshot valuation models. That is, they value the present earnings and present interest rates. They were bearish in 1990 at a time when I was wildly bullish. I knew things were not going to remain as bad as they were at that time. The reverse is now true. So I guess I disagree strongly with their definition of fair value. I think "value" is a normalized number. An average expectation for business activity going forward. I also think that they could be misunderstanding the sustainability of the low cost of capital and a high return on capital we have at present. How can aggregate U.S. business be worth 2.5x-3x the replacement cost of its assets? Many individual businesses can. That's called goodwill. But there is also such a thing as illwill. Those are companies that are earning less than a satisfactory return on their capital. For every "above average" company there must be below average companies also. "Aggregate Replacement Cost" has been mean reverting for 125 years in multiple countries where the data was available to test it. Even if the data are slightly wrong because of mismeasurment of R&D, software and the like, it can't be that wrong.
Can it?
I agree with your point about PEs as a whole and small caps in particular. Not all stocks are equally overvalued or even overvalued at all. My problem, (and this is strictly my own thoughts) is that I don't trust the income streams for a lot of companies any more. Experience tells us that when bubbles burst, all sorts of income streams are not sustained. It happen in Japan, SE Asia, US in the 20s etc...How can I value a company when I don't know if they can sustain their earnings when the bubble bursts. Of course this assumes I am right about the bubble. My only solution is to require a greater margin of safety. |
