Market Valuation

One of the most common questions asked by investors, aside from what stock to buy, is; “is the market cheap or expensive?”

So how can investors estimate what the true value of the market is today and where it might be heading in the future?

Who you ask will determine the answer you receive. Some market commentators, experts, advisers and other ‘helpers’ use the P/E Ratio as their measure of fair value, some use charts to show support and resistance levels and some just make an ‘educated’ guess. It is easy to see why many investors become confused and lose confidence in the views of financial professionals, particularly since the aforementioned approaches have such a poor track record of reliability.

Just as I estimate the values of businesses, you can estimate the value of the All Ordinaries Index. That’s because an index is simply a collection of businesses weighted by their market capitalisation.

Applying the same methodology that I consistently use to value individual businesses to the All Ordinaries Index, I get a fair value for the market of around 4,100 points. At the current market price of around 4,510 points, I conclude that the market is not extremely expensive at 10 percent above fair value but nor is it a bargain.

Knowing this doesn’t help me predict where the market is going to go.  Placing a value on the market or any business for that matter is not the same as predicting its price but without a valuation you’re flying blind and merely hoping the shares you buy don’t go down.  That’s not investing, that’s speculating.

Knowledge of what the All Ordinaries might reasonably be worth today provides confidence about how to act.  If the news is plastered with stories of losses in the stock market and all looks like doom and gloom, and if the price of the All Ordinaries index is substantially lower than its estimated value, its probably time to buy.

By Roger Montgomery, 1 September 2009

by rogermontgomeryinsights Posted in Market Valuation.

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Massive windfalls have indeed been doled out to the institutional shareholders of almost half of the top 200 companies in the last act of a scripted and predictable pattern of debt fuelled overpriced acquisitions, followed by rising interest rates, tightening credit conditions and inevitable asset writedowns. Its our very own cash for clunkers scheme!

The next act however is one that shareholders should watch carefully, lest they fall into the trap of paying too high a price themselves.

Giving a company more money irrespective of whether it is through a rights issue, a placement or most other forms of capital raising is akin to putting more money in a bank account; the end result should be more earnings. And so a company that is the recipient of a billion dollars should – if it is going to beat a bank account – deliver an increase in its earnings of at least 5 percent. If the risks associated with businesses and the stock market as well as the dilution that occurs from issuing additional shares are taken into account the increase should be greater still.

Failure to increase earnings means shareholders have gone backwards.

Of course at next year’s beauty pageant (earnings reporting season), companies that boast about record earnings or otherwise substantial increases, should be reminded by reporters, journalists, shareholders and analysts of the vast sums of additional funds they were given. They should also be told that earnings can increase substantially with little more than a bank account, a generous benefactor and a rocking chair.

By Roger Montgomery, 1 September 2009

by rogermontgomeryinsights Posted in Market Valuation.

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