Investors Beware: Ignore Pundits, Obey the Numbers

Thursday, 06 Oct 2011 09:21 AM

By Jacob Wolinsky

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“Where is the market headed?” is the questions on everyone’s mind today.

Most of the pundits will tell you that the stock market will decline due to the macroeconomic concerns. However, the consensus is usually wrong.

It does seem that the world economy is in big trouble. However the one positive note for investors is that the market is starting to get cheaper.

Every month, I measure the market based on eight different metrics. The metrics used are purely quantitative and avoid the “What if” game (What if Greece defaults? What if China crashes? etc.)

Looking at one of the most common metrics; the price earnings ratio on the past year of earnings (or P/E for the trailing twelve months, or TTM), the S&P500 is at 13.3, this compares to 15.6 just last month! The average is usually about 15 or 16, so this would indicate an undervalued market.

A low price to book value is one of the best indicators that the company is undervalued. A book value of one means that the company is trading at the same price as the shareholders’ equity over shares outstanding. Below one indicates that the stock trades for a lower value than stockholders’ equity.

The same is true for the total stock market. The average price over book ratio (P/B) for the market has been 2.41 over the past 30 years, today it is at 2.20.

The dividend yield of the S&P 500 is currently 2.15 percent. By contrast, 10-year Treasurys are yielding a record low of below 2 percent. If you just held onto the S&P for the next 10 years and the market did nothing, the return would be 2.15 percent compounded versus less than 2 percent non-compounded for Treasurys.

Finally investor sentiment is a good way of seeing when the market is close to a rally. When investors get very nervous and think you are crazy for mentioning stocks, it usually is a good buying signal. The American Association of Individual Investors (AAII) takes a survey every week to gauge market sentiment.

According to the most recent survey, close to 47 percent of investors are bearish. The normal average over the 24 years of AAII data is 30 percent bearish. This is a good sign of a potential market rally.

Warren Buffett bought back Berkshire Hathaway stock last week for the first time in the company’s history. This is not a metric, but a good indicator that stocks are cheap.

While the market could decline a lot further, investors should think twice about listening to all the perma-bears in the financial media.

(Disclosure: The author of this article is a shareholder of Berkshire Hathaway stock).


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