Hello,
I came across this recently on the Crossing Wall Street site. It is interesting that one of my college professors taught this in his finance class many years ago. With this, I thought I’d post it for your review. Perhaps, it is something you’d like to add to your own tool kit. It is in mine. And, it can also be used to compute the fair value of an index.
http://www.crossingwallstreet.com/archives/2012/05/worlds-simplest-stock-valuation-measure.htmlGood Investing,
Skeeter
Comments
For example Cramer uses another one conserving P/E divided by long term growth rate (percent) if number is less than 1 it is cheap. If it is 2 or higher it is expensive. Again, it is emphatically and may or may not not be supporters by other valuation measures.
I thought I take a moment and use the World’s Most Simplest way to compute a stocks valuation that recently appeared in the Crossing Wall Street Blog; and, I will apply this formula to the S&P 500 Index itself.
In review, the formula is as follows: Growth Rate/2 + 8 = P/E Ratio
I have provided a link to the formula for those that would like to read more on it.
http://www.crossingwallstreet.com/archives/2012/05/worlds-simplest-stock-valuation-measure.html
In review of Moringstar’s Instant Xray I will use its projected five year earnings per share growth rate for the S&P 500 Index which was currently listed at 10.33 as of 02/02/2013.
I have provided a link to reference this report.
http://portfolio.morningstar.com/NewPort/Free/InstantXRayDEntry.aspx?entrynum=10&runMode=MSTAR
Simply enter a ticker symbol on the entry page ... I used SPY and an amount. Then click view Xray Report. On page two you will find what the current earnings growth rate is for the S&P 500 Index.
If we take the 10.33 growth rate number and divide by 2 and then add 8 by the formula this computes to a 13.17 P/E Ratio.
Now, let’s take the estimated forward earnings estimate for the Index which Crossing Wall Street recently estimated at $112.49 for 2013.
I have provided a link below to reference this information.
http://www.crossingwallstreet.com/archives/2013/01/earnings-season-numbers.html
If we take the P/E Ratio and multiply this by estimated earnings then we arrive at a valuation. This works out to be 1481. With the Index’s Friday market close of 1513 then we can determine if the Index is trading above, or below, an estimated fair value by a comparison of the two numbers. In this case it appears the Index is trading above fair value by about 2.2% using this valuation method.
Now let’s check in Morningstar’s Fair Market Value Fair Value Graph and see if we are close to what it is showing. I have linked it below for your easy reference.
http://www.morningstar.com/cover/market-fair-value-graph.aspx
Bingo ... They are currently both reporting that stocks are trading about two percent above fair value.
I hope this gives you some insight as to one of the ways I use to compute an estimated fair valuation for the Index.
Have a great day … and, I wish all “Good Investing.”
Skeeter
Analysis earnings estimates often are bushy-tailed early in the annual predictions cycle.
The 10 % number that you pulled from the Morningstar reference seems to fall into that optimistic category. A forecast is only a forecast. Historically, the actual average increase in EPS growth rate is more like 5 % annually since about 1960. So be somewhat skeptical of this early estimate.
For a historical perspective, and much more detail relative to the S&P sub-sectors, I suggest you examine a recent earnings release published by economist Ed Yardeni. Here is a Link to the very current report:
http://www.yardeni.com/pub/PEACOCKSP500.pdf
Yardeni is addicted to this form of data presentation. I’m sure you can integrate these elaborate records into your tool kit.
Enjoy and Good Investing.
Hi MJG and Investor … Thanks for stopping by and for making your comments.
Picture a compass … It uses the magnetic North for its center of focus to provide a directional read and then one can plot their desired direction from the compass dial. It will be close but not exact.
Now picture a GPS … It uses a more precise system to compute direction and its read will be more accurate and will provide the more detailed directions.
In some situations, a compass is all that is needed while in others the GPS would be the direction finder of choice. In boating, I use both while in my car I have both but use the GPS navigation more frequently.
The quick and easy stock valuation system is much like the old fashion compass as it will get one close in value but it will not be an exact measure and was never intended to be. I like it because for one it is quick and two it provides meaningful information just as a compass does. It is interesting; one of my old college finance professors shared this formula with his students back in the early 70’s. I found it tucked away in my book. So it seems to have been around for a while, much like the compass. Perhaps not used much anymore by those in the industry and by the modern day investor.
Now Mr. Yardeni’s work is much like the GPS. It is more exact and for some, like me, it provides, at times, information overload. But, there again, if one wants more exact information then Mr. Yardeni’s research and reports are the more focused and provide the more detailed information. I have seen and studied them before and simply tossed them aside because of the information over load perspective for the purpose I was seeking. I wanted a compass and a barometer so to speak not a detailed research report.
Being an old boy scout the compass approach currently provides me with enough information to govern. I am a simple retail investor and some of my systems are so simple in nature, well they are just not in fashion, but I have found them to work. Much like the simple medication Asprin. Been around for centuries and still works.
Many take issue with Morningstar’s Market Valuation Graph … but, I have found it does provide meaningful information and is an aid to determine stock market valuation. It appears, to me, the Crossing Wall Street’s quick and easy method was designed as a quick first take and look type method and not the more in depth GPS unit type method. Yes, a thumbs up approach.
I like it … and, as I previously stated, I have placed it in my tool kit for a quick take type look.
I wish all … “Good Investing.”
Skeeter