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Strategies & Market Trends : Graham and Doddsville -- Value Investing In The New Era -- Ignore unavailable to you. Want to Upgrade?

To: porcupine --''''> who wrote (423)	6/20/1998 9:36:00 PM
From: Freedom Fighter	Read Replies (1) \| Respond to of 1722

Relative Valuation >But, a question that arises is whether or not there is an absolute > measure of "low", or whether relatively "cheap" (i.e., relative to >the rest of the Market) is the best we can do, lest we wind up >attempting to "time" the Market, even if we call it "pricing" or some >other rubric. I do look at relative valuation, but experience and observation of history leads me to believe that there are very overvalued and very undervalued markets. Therefore I use several models that compare the market itself to long term averages and other asset classes. Here is one example. The long term real rate of return on stocks is 7%. In today's market, measured on a peak to peak basis, earnings for the S&P500 grew at 6.3% in the present cycle. The current dividend yield is about 1.5%. If profit growth stays the same and PE's stay the same, the long term return from stocks will be 7.8%. (6.3 + 1.5) The 10 year inflation expectation is currently 1.8%. This means that stocks are priced to give a 6% real rate of return "under these assumptions". To get to a 7% real rate of return one of 2 things must happen. 1. Earnings must grow faster. 2. PE's must expand I have just written my reasons for thinking the probabilities favor a slowdown in EPS growth over the next few years in my Monthly Market View. Also, PE's are already at their highest level in history. This implies super risk! members.aol.com To return to a 7% real rate would require a drop in stock prices so that the dividend yield is up to 2.5%. That is a drop to less than 700 on the S&P500 from 1100. Ouch! If EPS growth slows double ouch! Surely there are many possible scenarios. We can also disagree on the assumptions about the future and what the real rate will be going forward. I just think the weight of evidence clearly indicates an overvalued market. I also find it interesting that Alan Greenspan has often talked about historical relationships and lower than usual risk premiums. My bond model suggests the same. So do PE comparisons to other periods of low inflation. I use more complicated models for evaluating individual companies, but I don't buy unless the real rate of return I expect is greater than 7%. The same is true for my bond vs. stock models. The rate of return must be greater than the risk premium average in recent times. Same with PE ratio and other models. >I think Warren Buffett's just-announced $22 billion tender for >General Re (news account copied into the following posting) is >telling on this point. As a long term Berkshire owner, what's your >interpretation of this acquisition? I summed this up in my previous post!