In an earlier post this week I referenced the “Rule of Twenty.” “The Rule of Twenty Can Make You Plenty” is an article featured in a Seeking Alfa article. I have linked this article for those that might be interested in reading more about it.
http://seekingalpha.com/article/309239-the-rule-of-20-can-make-you-plentyAnd another take on the "Rule of Twenty" by Capital Invetment Services. Below is a paragraph form their take that resonates with me. A link to their complete commentary on the subject is found below.
1982 to 2013
Average CPI% was 3%
Average Actual P/E ratio was 16.7X
"Currently, the CPI (less Food and Energy year-over-year %) has been increasing at a 2% annual rate which, according to the “Rule of 20” model, would suggest the S&P 500 P/E ratio should fundamentally be closer to 18 times. This would translate into an additional 25% rise in the market valuation.
We believe stock investors should be more focused on inflation conditions than the absolute level of the market P/E ratio. If inflation can remain near recent levels of about 2% (which we believe is likely), valuations have further room to improve and drive higher stock prices."
We remain focused on understanding the current trends in fundamentals because it gives us the best probability for success. And if you’re an active social media user, please consider sharing this topic with your acquaintances.
http://www.capinv.com/rule-of-20/Have a good weekend … and, I wish all … “Good Investing.”
Old_Skeet
Comments
Let's hope for higher earnings.
Personally, I think stock prices became derivatives on a company over the last two decades rather than be a direct measure of company valuation that they started as. By that, I mean the prices were determined more by supply of money into the markets looking for shares and the gains determined by this betting against each as a first derivative of earnings using only the direction rather than magnitude.
Vaguely remember a book a decade ago that busted Wall Street myths like 'rule of 20'.
That is an interesting point that you make regarding stocks prices have now become derivatives rather than a direct measure of a company valuation. With this ... It raises a question ... How should stocks now be valued? Any idea?
Old_Skeet
It has always been this way for pre-ipo companies in the venture capital world. Now that seems to be happening in post-ipo markets as well since public companies are not required to have dividends or even earnings to provide gains from direct betting with agreement only on direction.
Near-term, P/E seems to be a very dependent variable..."a derivative," as you describe.
But in the limit, seems to me it must converge to reflect a reasonable return on invested capital.
Else, we shouldn't be investing in the stock market.
Ha! In case of Jeff Bezos, the limit may be a very, very long way out!
http://www.zerohedge.com/contributed/2013-12-14/signs-top-and-few-opportunities-value
Something to think on.
Old_Skeet
That said, at the end of the day, dividends and reinvested cash must come out of earnings. I suspect you can fool earnings for a while but over time, the truth must come out.
'Cause, like you and I know, all things based on falsehood will eventually be proven wrong.