Is the All Ords cheap?
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
This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.
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