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Politics : Ask Michael Burke -- Ignore unavailable to you. Want to Upgrade?

To: gambler who wrote (34747)	10/29/1998 12:40:00 PM
From: Knighty Tin	Read Replies (1) \| Respond to of 132070

Gambler, My own model, silly though it is, is proprietary and I sell it to folks who don't know any better. However, it is very similar to the model William Sharpe uses in his Modern Portfolio Theory textbook. You can find that in any library and I would bet it is on the net somewhere. Basically, a dollar of eps is worth more when rates are lower. Let's take a couple of outrageous examples. If Pfizer is earning $1 a share, and is priced at $10, it has an earnings yield of 10% and a pe ratio of 10. (the numbers are never this easy in real life. <G>) This assumes no eps scams, and Pfizer is a clean co., so I can use their name in vain in this example. Now, the question is, is that $1 of eps and 10% earnings yield worth more when T-Bills are yielding 14% or when the T-Bills are yielding 3%? That is pretty obvious. A stock offering 10% eps yield when I can get 14% from T-Bills is never going to see the Promised Land of my portfolio. If T-bills are yielding 3%, taking a risk to get a 10% eps yield may make sense. We also have to figure in the stock's risk of eps, its potential growth, etc. But the earnings yield vs. the risk free rate is a key factor is deciding that a stock is a good buy. Right now, Pfe is at $100 with eps of less than $2, but let's use $2 as the number. That gives you an eps yield of 2% with T-Bills at about 5%. I know I am a bit loosey goosey with these #s, but the idea is to illustrate the though process, not value PFE. Consesus estimates predict eps growth of nearly 25% next year. My 5 year forecast is for 20%. That is solid growth from a solid co. But the 5% T-bills are risk free and there is risk aplenty in PFE's eps estimates, including lawsuits, pipeline risk, and pricing competition for older drugs. My formula tells me that 5 year 20% eps growth at this risk level with this risk free rate should be worth about 24-32 times current eps. That assumes that rates do not go higher. Which means that PFE is close to 100% overpriced. Now, where I differ with the analysts who say it is cheap or fairly valued is mostly in the risk level. I bought PFE during the Billary Health Plan fiasco, and I know that it is not risk free. I may disagree slightly with analysts on the future of the risk free yield, but it is the risk of the stock that separates us on this good co. I sse some risk, they see none. They are wrong. In fact, they tend to see no risk on any stock that hasn't preannounced within the last 24 hours, whereas I see risk lurking everywhere. Hope this helps. MB