Gst, about valuations. You have a disagreement with any of this?
>If you look at it from a valuation standpoint, the answer can be very sobering -- although valuation is only one criterion for stock selection.
Following Monday's plunge, the price/earnings ratio of the Standard & Poor's 500 was 28.02. Historically, it averages about 14.5.
It gets worse. The S&P 500 is trading at more than 2.5 times median historical norms by other value measures, such as price/revenue, price/book value, price/cash flow and price/dividends, according to John P. Hussman, publisher of Maryland-based Hussman Investment Research & Insight.
He believes stocks can decline as much as 40 percent from here. And you can't dismiss him: In early 2000, he was saying that the Nasdaq was likely to lose between 65 percent and 83 percent of its value.
His view was considered extreme. Not now.
He says that overvalued markets can go on for some time. We saw that in the 1990s. However, "One of the unfortunate things I hear is, 'Don't worry about the short term, think about the long term,' " says Hussman. "The unfortunate reality is that overvaluation implies unfavorable long-term returns."
Hanging over the whole question is the low quality of corporate earnings. Accounting ledger-demain has bloated them in recent years. Recently, The Wall Street Journal figured that if earnings of the S&P 500 companies were calculated using generally accepted accounting principles (GAAP), the multiple would be 36.7. Post-Sept. 11, that's probably about 32, says Hussman.
Where does that leave us? Very vulnerable. In coming days, one company after another will be giving new guidance to investors, shaving previous earnings expectations.
Among the accounting abuses have been the non-expensing of stock options for employee compensation and the promiscuous use of so-called "non-recurring" charges to cover past strategic errors. Also, the booming stock market of the 1990s swelled profits by reducing the expense of defined-benefit pension plans.
These three factors led to a significant overstatement of earnings in the S&P 500 during the period, according to researchers at Wall Street's Sanford C. Bernstein & Co.
Conservatively adjusting profits for all three factors, Bernstein researchers figured that the earnings per share of S&P 500 companies from 1995 through this year (estimated), would have dropped from 5.1 percent a year to 1 percent a year.
"It's clear that the quality of earnings in the latter half of this business cycle was poor," says Bernstein's Michael L. Goldstein. Expectations for a powerful profit recovery next year appear quite optimistic, he says. |
