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Strategies & Market Trends : Buffettology -- Ignore unavailable to you. Want to Upgrade?

To: jhg_in_kc who wrote (307)	9/22/1998 1:38:00 PM
From: Robert Douglas	Read Replies (1) \| Respond to of 4691

Forgive me for stepping in to your discussion but I have to make one comment. You quote someone as saying: 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. I have always been under the impression that the higher risk investment would carry the lower P/E. Since you are comparing a bond's yield to the P/E of a stock, you must compare the relative risks of each instrument as well. Is there anyone here that doesn't know which is the riskier? Additionally, the premium paid for a growing stream of earnings would only be greater if the that growth rate is greater than the yield in question, in this case 5%. Is the long term growth rate of earnings going to be greater from this level? Perhaps, but not much more. -Robert

To: jhg_in_kc who wrote (307)	9/22/1998 7:01:00 PM
From: James Clarke	Read Replies (1) \| Respond to of 4691

re: Interest rates vs. P/E multiples I am not going to respond to that whole message. We each posted our reasoned diatribe. Further discussion is superflous. But on this matter of finance, you are absolutely correct that low interest rates justify higher p/e ratios. But the p/e ratio must also take into account whether the "e" is likely to rise or fall. I will submit again that the Return on Equity of the S&P 500 is currently about 19% (and yes, I know what return on equity is - I am not confusing it with stock returns), way in excess of historical averages. What I am arguing is that earnings are going to fall, not rise. Which means I want to pay a fair price (based on interest rates) for sustainable earnings, not peak earnings. And that tells me to be very careful until everybody else's expectations come closer to my own. It is happening - Wall Street analyst estimates are falling in just about every sector. Maybe Dell is the exception. I am not willing to make that bet, and I am sure you are intelligent enough to understand that your downside is enormous if you are wrong. At 75x earnings, some of us are arguing that even if you are right, the upside is limited. JJC