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Strategies & Market Trends : Gorilla and King Portfolio Candidates -- Ignore unavailable to you. Want to Upgrade?

To: EnricoPalazzo who wrote (43695)	6/20/2001 8:56:13 PM
From: Stock Farmer	Read Replies (1) \| Respond to of 54805

ardethan: Wow, we missed. Let me try slowly. >>Aside from the fact that I have no idea why it matters what the "total market" costs (Me, I buy stocks, not markets), << It matters because unfortunately for you, your sole opinion matters squat in the universe. For example, no amount of your thinking XYZ should go to $xxx stopped the market from crashing underneath your feet. The same logic holds true for any individual. So when adopting a macro stance it is vitally important to recognize that the planet is populated by other people and that their opinions matter too. Indeed, collectively, they matter more than your own. >>you seem to be forgetting the rather important fact of limited liability...Companies that are losing money absolutely are not worth some positive multiple of their earnings--that would give them a negative net worth, whereas limited liability ensures that a company is worth at least zero.<< Nitpicks of semantics aside, perfectly true. Completely relevant and not forgotten. >>Let's say that there's some "natural" PE (call it K) that is proper for all profitable companies. (Note: you seem to favor this view; I don't).<< Nothing could be farther from the truth!!! I do not favor such a view.. the rest is gibberish with respect to the point I was making, so as long as you disagree with the conclusion then both of us can agree on that. >>Let's also say that there are 20 companies, 10 of which are making $2 per year, and 10 of which are losing $1 per year. The value of the 10 profitable firms, in aggregate, will be 20*K. The value of the ten unprofitable firms, in aggregate, will be at least 0. So the total value of the market is at least 20K, and the total profits are $10, so the P/E would be at least 2K, which is twice what the "natural" P/E should be of any firm, even though the market isn't overvalued (the unprofitable firms are all selling at 0!).<< OK, let's start again from a clean sheet. Think of a company like GE. It has a value. It is creating value and operates at a profit. Its equities have a price. Each division within GE is run as a small business. P&L etc. The profits and losses of each division are rolled up to create the net profit and loss of the company, which results in earnings, from which you can extrapolate a fair price by assuming growth rates and so on (my previous posts). You could take this fair price and divide it by E to get a PE ratio. Now imagine for a second that GE consists of all companies traded on NASD. Subsidiaries (so we still keep your limited liabilities intact). We will do two separate calculations. The first calculation is to sum up all the profits and losses. Just like GE divisions. We will come up with "Earnings" from this mega company. And before peeking to see what this company traded at on the planetary exchange, we could figure out a fair price by making some growth assumptions, calculating a PE and dividing our total earnings into this number. This is "the whole". Then (peeking) we do another calculation. We add up what the planet thinks this is worth. Look into your portfolio, you think you have a net worth. So do I and so does everyone who owns a slice of a slice of this whole. So we add up all of these slices of slices and get a "Price". We need to know this price because it's what everyone thinks the whole thing is worth. The sum of the parts. Now, when the whole is not equal to the sum of the parts, we have a problem. When it's bigger it's the good kind of problem to have. This is the kind of problem we hoped for when Cisco purchased Monterey. But when the whole is smaller, well surprise surprise. Kind of like Nortel shareholders are feeling right now. If there isn't enough value to go around, then someone gets short changed. If it doesn't matter to you, would you care to please step to the back of the line? Because it matters to a lot of folks. Now, let's take this back to the realm of reality. You say "but I only invest in tech stocks, so this doesn't matter". But it does. Because somewhere out there are a few million people who mostly invest in other things but also own some of those tech stocks you hold. Sadly for you, they don't take much stock in what you think, just like you don't take much stock in what they think. So when their worthless companies go from being worth something to not less than nothing (but still nothing) and they rush like lemmings to raise cash to satisfy margin calls... maybe they sell more of those tech stocks than you feel like buying and the bottom falls out of the market. Maybe they don't have enough guts to lend a telco another dime (they are old economy any way). Maybe your tech stocks get affected. Maybe you wake up one morning one digit fewer on your net asset value. Sound familiar? I personally like to pay attention to this number. Even though I admit it is completely fictional and meaningless. Because it matters. John.