How 'Fairly Valued' Stocks Suddenly Become Expensive

Discussion in 'Trading' started by ByLoSellHi, Feb 8, 2007.

  1. The Future of Corporate Profits: The "E" in the P/E Equation

    Posted on Feb 8th, 2007

    A great, short explanation:

    Vitaliy N. Katsenelson, CFA submits: I wrote this article last year, on the risk that high corporate margins present to investors. Here is updated excerpt from that article:

    Today’s stock market valuation is higher than it may appear. As margins revert to the historical average (and they always do), corporate earnings growth will either decelerate — disappointing Wall Street expectations of 8% earnings growth (according to First Call) for the S&P 500 over next five years — or decline, driving earnings, the “E” in the P/E equation, down.

    The broad market index fund investor may be in a pickle when a cheap market suddenly becomes more expensive. If today’s corporate profitability reverts to the mean profit margins observed over the last 25 years (8.8%), corporate profits would decline almost 31%.

  2. A reversion to the mean would be nasty by itself. However, a more likely scenario is that earnings can return to the mean AND then keep trending lower to become greatly undervalued. That's a proper cycle of events. Going from fairly-valued to over-valued and back is optimistic BS.
  3. As long as stocks can offer at least a 3% better return than bonds the market will do just fine.

  4. But earnings now came in at 9.2%, historical average is 8.8%, and treasury bond yields are around 5%, with corporate bond yields (high quality) around 7%.

    That margin of error has closing for equities, IMO.

    We may very well see sub 8% earnings growth in the coming quarters, in which case, bonds will rally big time.

    Bill Gross is no dummy, by any standards, and believes a bond rally is about to ensue.

    I do realize he has a vested interest, but that doesn't nullify his call.

    02-08-07 07:56 PM

    Earnings Slowdown

    For the 351 members of the S&P 500 that reported fourth- quarter results, average earnings growth was 9.2 percent, according to data compiled by Bloomberg.

    If earnings expansion remained at that level, it would end a 13-quarter streak of profit growth above 10 percent, which matched the longest such streak since 1950, according to Thomson Financial.

    So, if you buy in here, you're paying extremely high prices for shares based on their last 13 quarters' worth of performance.

    You'd better be confident their earnings won't decelerate.
  5. If interest rates move up it will have a devastating effect on the market right now. 6 months from now? Who knows, but right now market internals are very strong. This can obviously change quickly, but a downturn is of no concern to me until some signals change.
  6. But earnings have dropped precipitously.

    They have come in at 9.2% this last Q. It's the first time in 13 quarters that they haven't registered in the double digits, and there is every reasonable expectation that they will fall further in the quarters ahead.

    Add in the interest rate/inflation issues, and we have a fluid and highly volatile situation when it comes to forward earnings.
  7. Ha ha

    ...more meaningless bearish rubbish

    And it came from seekingalpha; a worthless site

    Seeking alpha doesnt even discuss stocks anymore. It is cornucopia of crap written by eggheads who have probably never traded a single stock.