Sir, there is a cat named Chuzzlewit, a very smart and alert cat and a keen observer of human behavior. He advises naive investors like me over on the Dell thread. Here is his response to your bearish post to me about Dell and a Dow 5000 market:
Talk : Computers : DELL
To: jhg_in_kc (66621 )
From: Chuzzlewit
jhg, I think you must like to read horror stories and scare yourself.
This is an example of fear beyond reason. Here's why:
1. Dell trades at about 75 times earnings.
wrong. It trades at about 75 times last years earnings. The multiple is considerably less for this years' earnings, and given the fact that Dell manages expectations very well it is probable that Dell will continue to surprise to the upside.
2. Even if earnings double in three years, and the stock winds up
trading at a high multiple of 30 times those earnings, which it won't,
you've lost money. This is pretty simple math.
The devil is in the details, or in this case the assumptions. Here are
the implicit assumptions:
a. Earnings doubling in three years implies an annual growth rate of
only 25%!!!
b. Stock winds up trading at a high multiple of 30 times those earnings
implies that there is an increase in long term interest rates
and that there is a permanent slow down in Dell's growth rate.
[I] have great respect for the business model. But so does Compaq, IBM,
and every other potential competitor. The barriers to entry are weak,
which means be careful.
3. As we have continued to point out, the barriers to entry are
formidable. The only people positing this position are the ones who have
not studied the problem in detail.
*** Your tormentor goes on to invent a nightmare designed to frighten
children and naive investors:
... the return on equity on the Dow today is something like 19%, a
historic high. The historical average is 11%. That tells me there is
some downside in earnings. And you are paying a multiple of over 20x on
those earnings, which are arguably at a peak. So take that multiple down
to the historical average of 15x, and take the ROE down to - I'll give
you 15%, which is generous, and you've got downside risk of what, 20% on
earnings and 25% on the multiple. That tells me the downside risk is
well below 6000. More like 4500-5000.
I suspect that he is not talking of the ROE, but the return to the
investor. But note the subtle assumptions implicit in these statements:
the historic average is 11% and a P/E of over 20x. You see, what he is
doing is assuming away economic realities. The reason P/Es have expanded
over their historic averages is because long-term interest rates are
low. 30 year bonds are yielding a little over 5%! Invert that number and
you get a P/E (yes, the inverse of yield is P/E!!!) of 20x. Now, since
investors put money into equity markets in hopes of increases in future
earnings and cash flows, it makes sense that the current earnings yields
for equities would be lower than comparable yields for fixed income
securities. Put another way, if the 30 year bond has a P/E of 20, then
the stock market needs to have a P/E well in excess of 20.
There is much more in the way of silliness in these fears, but I am
beginning to suffer from cramps in my tiny cat paws, so I will leave it
here.
TTFN,
CTC |
