Are We There Yet?
Has the market yet fully recovered from the beating it took? Everyone who cares, raise your hand!
Now look around. Everyone whose hand is up is a member of the herd!
“Well, I care if the stocks I own haven’t yet recovered,” you might say. But why should that even make a difference? Unless you have a need to sell them right now for some personal reason, you need only to wait a little longer—provided those underlying companies meet the standards for high quality we’ve talked about. And, if they do, you might even consider buying some more!
We’ve just been experiencing a “market correction”; and, as with any “correction,” something that was wrong is made right. Generally, as is the case today, the “wrong” is that stock has been in the hands of those who don’t have a clue as to its real value, expecting someone else to pay more for it than they did.
What’s “right” is that the shares of the well-managed companies are now being gathered up by those who know their real value. And the prices of shares in those companies are rising nicely to regain their true, rational value.
Because there are relatively few companies that meet our high standards, the market average continues to languish. And, as happens in most down markets, it will continue to do so for some time while the quality companies recover smartly.
Are we there yet? Heck, “we” business owners ain’t never left!
But it might be a while yet before “they” come back.
Food for Thought, Fundamental Investment Views, Investment Concepts, Successful Investing
Ellis,
A question regarding “Rational Value.” If the current price is not recognizing or reflecting the current Rational Value, why did past prices come to set the Rational Value at that time? At one time prices established what is now the Rational Value. Why was that historical event, or combination of events, correct? Perhaps I still don’t fully understand why you value a portfolio on Rational Value rather than current prices.
Lowell
Lowell,
The Rational Value is a function of the “Signature PE”——the mean or median PE over an extended period (which I prefer to calculate as the trailing 10-year median PE.)
In the course of our stock study, we develop a Historical Value Ratio (HVR – current PE divided by the 10-yr. median PE) or Relative Value (RV – current PE divided by the 5-year average after eliminating outliers). And, to calculate the rational price, we simply divide the current market price by the HVR or RV.
The rational value is not determined by one historical point or event; it’s determined by a mid-point of a set of values over an extended time period——a point around which the PE has fluctuated with equal amplitude and around which it’s reasonable to expect the PE to fluctuate similarly in the future, provided the company continues to earn the confidence of investors with its steady earnings growth.
It’s therefore reasonable to assume that the market value of the portfolio will fluctuate around that point. If the market is “irrationally exuberant,” it will certainly come back down to (and probably through) that point. And when investors are “irrationally despairing” as they have been in recent months, it will eventually return——and likely surpass——that value in the future.
Because the Rational Price is tied to earnings, it’s dynamic and grows as earnings grow. Rational Price is merely an extension of the core principles taught by NAIC and gives the investor an “absolute” value on which to base an evaluation of her portfolio at any time. I believe to be a valuable metric to help us keep the faith during bubbles and busts.
Please hold my feet to the fire on this if you disagree or see a flaw in this logic.