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

To: Freedom Fighter who wrote (649)	8/18/1998 6:41:00 PM
From: Anton Posch	Respond to of 1722

When one computes a dividend yield for the "market", is this based on all stocks, or is it calculated only for those stocks that actually pay dividends? If dividends in general are becoming less popular as a means of distributing profits, how would this affect the preceding analysis? Also, how is this of relevance to a growth stock investor who primarily owns stock in companies that don't pay dividends?

To: Freedom Fighter who wrote (649)	8/19/1998 7:01:00 PM
From: Freedom Fighter	Read Replies (2) \| Respond to of 1722

Contrarian Investment Strategies by David Dreman I just picked up the book and started scanning it. It's full of useful information and I recommend that you get it. I especially like the crisis investing section. I have used that approach successfully in the past. I bought bank stocks in the early 90's and brokers after the 87 crash. It works! Reynolds, I especially recommend this book for you. His thinking is almost identical to yours on many issues. I can't see how you won't both enjoy it and get something from it! It's a very good book! Here's some of my personal thoughts: I had a problem with the section on risk. It contains what I am sure is accurate historical data used to compare the risks and returns of holding different asset types over various periods of time. All such studies will certainly favor stocks over all other asset types. Stocks have historically almost always been discounted to return higher rates than competing asset types. (That's why I keep most of my portfolio in stocks most of the time.) The problem is in the assumption the chart makes that at all market levels and all levels of interest rates the probabilities of performance are the same. This assumption is clearly an error that excludes valuation judgment and changes in relative discounting over time. Here is a very basic example. In the 50's when stocks sold at 10X earnings (a 10% earnings yield) and had a dividend yield of 5+%, bonds often yielded less than 3%. The chances of under performance by stocks over even a very short period of time (2 -3 years) was practically non-existent. The risk premium was huge! As I write, the S&P500 is trading at around 28X earnings (an earnings yield of around 3.5%) with a dividend yield of 1.5%. The highest quality corporate bonds yield just under 7%. The tables presented make no allowance for the different probabilities that are associated with these two very different sets of circumstances. The table presents the probabilities during the average set of circumstances. The probability of under performance by stocks over the next few years is clearly much higher now than during the 50's. The discounting is dramatically different. I don't think anyone would argue with that. The tables do not reflect this very significant fact. In my view, it is specifically the role of the value investor to determine the risks and rewards of each asset class at any given point of time. Again, stocks are almost always discounted to return more than bonds or cash. (including now) Given this fact, I suppose that one could logically argue that an investor should always be 100% invested as long as stocks continue to be discounted that way. It is difficult to counter that argument. However, that discount spread varies widely over time as the example above clearly demonstrates. History also suggests that all markets in all countries present terrific buying opportunities from time to time. In order to take advantage of such opportunities requires that the investor be holding some other liquid asset like cash or bonds at the time the bargains present themselves. That is how the truly spectacular fortunes are made. An investor should ask him or herself if getting an extra 1% or so for the next few years (on a discounted basis) is worth the risk of a potentially significant decline from these levels. Even a decline to the upper end of average valuations would produce significant losses from here. More important, an investor is risking the loss of an opportunity for some truly spectacular returns if a bear market presents itself. Is 1% plus or minus worth it? In a portfolio split 50% - 50% in today's market, an investor might be giving up less than 1 percent annually while giving himself the opportunity for very large gains if a significant correction occurs within even 5 years. In the 1950's I would have been 100% invested and on margin. Today is a different story. It is my view that an investor should construct his portfolio based on this type of risk/reward analysis as well as his own personal circumstances. The second problem I had was with industry relative valuation. I want to be clear here because I tend to trash relative valuation often. I happen to use it all the time. It works! My point has been that it suffers from one very serious defect that can be quite costly. Relative valuation accepts the market or industry valuations in general as appropriate. Since most markets are reasonably priced at most times this is usually no problem. However, there is almost no doubt in my mind that markets and industries of all types in aggregate can be significantly mispriced at times. Finding the cheapest stock in a badly mispriced market or industry can still lead to investment disaster. I continue to believe that competent "intrinsic value" investing will outperform competent "relative valuation" over the long term. Buying the cheapest internet stock at present may still work out quite badly. Wayne Crimi Value Investor Workshop members.aol.com