Remarkable spread in stock valuations at present

[Running_Man]

Like OS, I don't buy that passive investing messes up valuations. The way I look at it, as long as there is a "critical mass" of traders that are looking at valuations (and not just buying the index), those are the ones that are setting the prices.

The biggest volume of traders is algorithmic and is mostly extremely short term. In other words this is efficient market hypothesis working trying to take advantage of short term fluctuations in expected value of asset classes. This has nothing to do with real value and everything to do with relative value. These algos are for the most part just hyped up and less leveraged versions of Long Term Capital Management. With changes in interest rates, junk bond debt, volatility, currency fluctuations, commodities etc the algorithms are utilizing complex trading systems determining which of the various asset classes have the highest expected value and switch between the classes. This is 70-80% of all daily trading.

Price Discovery comes in large clumps when prevailing wisdom shows it will not work anymore - examples General Electric, Valeant, Theranos. Weakness and flaws in the logic of the companies was evident far before the fall in most cases. But it takes an incredibly long time for the price discovery to actually work it's way through the system.

I always liked Charlie Munger, basically the brains behind the grandfatherly curtains, can't find the quote but he was once asked what he would do if he went bankrupt, he said if he had Value Line $10,000 and 20 years he'd be a millionaire again.

 

[Running_Man]

Did you look at the video?

Personally, I think the market is efficient in the long term but can be very inefficient in the short term. The inefficiency is mostly identifiable in the rear view mirror, though. Not so much through the windshield. That is why stock picking is almost always a losing strategy. All of the stock pickers say they are going to find and take advantage of market inefficiencies in order to produce winning performance.

Richard Thaler says the average investor should just buy passive overall market indexes, yet has a fund that seeks to manage asset classes through short term windows by taking advantage of overreactions to earning reports for instance. Invests in small companies because he believes they are under priced and will bring a far higher than market average return. And since 2009 has doubled the total stock market performance by utilizing this strategy. Is one of the ALGOs doing price discovery in the market.

 

[OldShooter]

Richard Thaler says the average investor should just buy passive overall market indexes, yet has a fund that seeks to manage asset classes through short term windows by taking advantage of overreactions to earning reports for instance. Invests in small companies because he believes they are under priced and will bring a far higher than market average return. And since 2009 has doubled the total stock market performance by utilizing this strategy. Is one of the ALGOs doing price discovery in the market.

No surprise; there are always stock-picker funds that outperform over selected periods. I am too lazy to look at all the Fuller & Thaler funds over various time periods to see if there is anything but luck happening. But the problem with stock-pickers remains; how to know ahead of time which stock-picker will outperform?

(The fact that Thaler is making money from his name being attached to a relatively expensive stock-picker fund really has no bearing on whether his recommendation for the average investor are correct. And, according to Marketplace: "Thaler doesn’t appear to be directly involved in the management of the funds.")

 

[Running_Man]

No surprise; there are always stock-picker funds that outperform over selected periods. I am too lazy to look at all the Fuller & Thaler funds over various time periods to see if there is anything but luck happening. But the problem with stock-pickers remains; how to know ahead of time which stock-picker will outperform?

(The fact that Thaler is making money from his name being attached to a relatively expensive stock-picker fund really has no bearing on whether his recommendation for the average investor are correct. And, according to Marketplace: "Thaler doesn’t appear to be directly involved in the management of the funds.")

Ummm if you look at the website Thaler is the Principal listed at the top of the management of the firm, yes he does not actually manage a fund, he merely runs the whole operation and gives as he says the managers the rules to trade by.
https://www.fullerthaler.com/single-post/2017/10/10/Investors-make-mistakes---Dr-Richard-Thaler-Principal-at-Fuller-Thaler

 

[Running_Man]

Back to the original topic, which is the potential split in the market between over valued and spectacularly undervalued stocks. While I believe in most circumstances you can find an undervalued stock, at times like this with some patience they will become further undervalued.

 

[gstillson]

Back to the original topic, which is the potential split in the market between over valued and spectacularly undervalued stocks. While I believe in most circumstances you can find an undervalued stock, at times like this with some patience they will become further undervalued.

Maybe, and for awhile but you can't wait around forever. Case in point is Microsoft before Balmer was replaced. The stock was languishing around $25 to $30 a share and had a ton of cash (really literally much more than a ton if stacked using $100 bills). It was very undervalued with the revenue from Office and Cloud services.

Fast forward just a few years and it is topping $100 a share. Can't wait forever.

 

[Running_Man]

Maybe, and for awhile but you can't wait around forever. Case in point is Microsoft before Balmer was replaced. The stock was languishing around $25 to $30 a share and had a ton of cash (really literally much more than a ton if stacked using $100 bills). It was very undervalued with the revenue from Office and Cloud services.

Fast forward just a few years and it is topping $100 a share. Can't wait forever.

Funny you should mention that particular stock, one of my favorites I noted in 2012 with stock price at 27. At the time expected a 17% dividend increase per year, didn't quite get that but the stock has appreciated 25% per year since then, there was quite a mixed reaction to MSFT back then, excepting you will note from some of the individuals who actually look at individual stocks
http://www.early-retirement.org/forums/f44/microsofts-lost-decade-62113-2.html#post1211767

 

[conversationalphrase]

No surprise; there are always stock-picker funds that outperform over selected periods. I am too lazy to look at all the Fuller & Thaler funds over various time periods to see if there is anything but luck happening. But the problem with stock-pickers remains; how to know ahead of time which stock-picker will outperform?

I did a bit more research on this, because I've sometimes seen market prices that seem to be over-reactions. I believe the Fuller and Thaler fund that is discussed is FTHSX. According to the Fidelity fund research tools FTHSX has underperformed the S&P 500 in the last 1, 3 and 5 year periods and has a 3 year Sharpe Ratio of 0.72.

 

[Spock]

That's a common and somewhat attractive the-sky-is-falling argument for the negative effects of passive investing. Said another way, the argument is that passive funds significantly reduce the quality of price discovery because they ignore the fundamentals when buying and selling.

But this argument misses the fact that index funds trade very little. The last figures I saw were that passive funds held about 40% of the US market cap but represented only about 5% of daily trading. So even if passive funds top out at, say, 60% of the market cap the stock pickers doing their price discovery will probably still represent over 90% of trading. YMMV but I am not worried.

(BTW passive investing has nothing really to do with momentum. The only reasons a passive fund sells or buys are (a) changes in its benchmark index or (b) inflows or outflows of funds. There are momentum funds but I don't think they are a huge influence on the market. Do you have any numbers?)

According to a report by JP Morgan, passive and quant/algo trading make up 60% of trading volume.
https://www.cnbc.com/2017/06/13/dea...regular-stock-picking-jpmorgan-estimates.html


The robo HFT volume alone is just about 50% of volume and skews the statistics for individual investors downward.


Between HFT, passive, and algo there isn't much room for human decision making.

 

[gstillson]

Great examples of companies that are "historically" cheap (and with great dividend-to-cost percentages)..

- T (7.25%+ divvy; PE of 5, fwd PE of 7.95 - SERIOUSLY?)

- F (7.6% divvy; PE of 5.15, forward PE of 5.63 - ditto)

- CVX (4.1% divvy; more reasonable PE but under-valued by ~20% per M*)

..the list goes on. You can buy some very good companies for CHEAP nowadays..just avoid the high flying FANG stocks. Totally agree on the "bifurcation" currently in the market..

I am interested in finding more of these companies and compiling a list to be used as potential candidates for stock picking if we get a continuation of this supposed valuation spread.

So far we have discussed T, F, CVX and GILD

low PE isn't everything though, you want to see a decent market for the product and a manageable debt load (along with good cash flow). You can easily get caught up in things like Seadrill, which was paying something like a 12% dividend before dropping from $40 to $0.19.

In biotech I like the bigger dividend payers with good PE and balance sheets, Gilead, Merck, Amgen, Pfizer with Gilead standing out as the best potential value right now (Merck is not bad but even with their Keytruda it takes a lot to move this beast).

 

[imoldernu]

Sunday's WAPO article:

Markets poised to finish year with worst performance in a decade — and the volatility seems certain to continue

https://www.washingtonpost.com/business/economy/markets-look-toward-new-year-will-it-be-happy/2018/12/29/452829fa-0ad3-11e9-88e3-989a3e456820_story.html?utm_term=.7ef49ad2679c

 

[OldShooter]

According to a report by JP Morgan, passive and quant/algo trading make up 60% of trading volume.
https://www.cnbc.com/2017/06/13/dea...regular-stock-picking-jpmorgan-estimates.html

The robo HFT volume alone is just about 50% of volume and skews the statistics for individual investors downward.

Between HFT, passive, and algo there isn't much room for human decision making.

Interesting numbers. Since reading "Flash Boys" I have believed that program trading needs to be regulated. The recent excitement in the markets has only confirmed my belief. I have read that the fix might be as simple as inserting a random delay, measured in milliseconds, before a trade is given to the market. Even if the fix is more complicated, though, I see no social value to program trading and would like to see it eliminated. Not that anyone cares what I think.

& to the point of price discovery, the JP Morgan numbers really confirm that passive investors are such a small factor as to be negligible, whch was my point.

(FWIW, I think any serious investor should read "Flash Boys," just to understand a little bit of what we are up against. https://www.amazon.com/Flash-Boys-Wall-Street-Revolt/dp/0393351599 It's one of the reasons I occasionally make a post that is skeptical of a forum member's analysis of a strategy or a stock. With respect to market information IMO we individual investors are midgets in a land run by giants.)

 

[Spock]

Interesting numbers. Since reading "Flash Boys" I have believed that program trading needs to be regulated. The recent excitement in the markets has only confirmed my belief. I have read that the fix might be as simple as inserting a random delay, measured in milliseconds, before a trade is given to the market. Even if the fix is more complicated, though, I see no social value to program trading and would like to see it eliminated. Not that anyone cares what I think.

& to the point of price discovery, the JP Morgan numbers really confirm that passive investors are such a small factor as to be negligible, whch was my point.

(FWIW, I think any serious investor should read "Flash Boys," just to understand a little bit of what we are up against. https://www.amazon.com/Flash-Boys-Wall-Street-Revolt/dp/0393351599 It's one of the reasons I occasionally make a post that is skeptical of a forum member's analysis of a strategy or a stock. With respect to market information IMO we individual investors are midgets in a land run by giants.)

In addition to the book, there are several interviews etc including a 60 Minutes segment on youtube.


The fix is brain dead simple and cheap. We used suitcases with multi-kilometer spools of fiber optic cable in our lab to simulate distances between computers. Route all traffic leaving the site (except connections to there backup disaster recovery site) through these distance simulators and they lose their "high speed" advantage. I think I saw somewhere were the people mentioned in the Flash Boys use the same tech for the trading floor they were building.


This is probably worthy of a separate thread, but I've never understood why the SEC requires quiet/blackout periods for news like quarterly reports to ensure everybody gets the same data at the same time
but then turns a blind eye to companies spending megabucks to set up high speed data links so that they can get trade data 5-10ms before anybody else and front run the trade.

 

[OldShooter]

... This is probably worthy of a separate thread, but I've never understood why the SEC requires quiet/blackout periods for news like quarterly reports to ensure everybody gets the same data at the same time
but then turns a blind eye to companies spending megabucks to set up high speed data links so that they can get trade data 5-10ms before anybody else and front run the trade.

Money. Somehow. Somewhere.

 

[Spock]

Found it:

 

[Running_Man]

I feel actually sorry for people that think in a 1/3 of a second a researched idea of value is erased, yet feel a passive approach to world wide investing in a markets where accounting standards are minimal and bribery is a way of life will assure their retirement by force of statistical science.


https://www.forbes.com/sites/jwebb/2016/10/27/85-of-managers-resort-to-bribery-when-trading-in-developing-economies/#3718fa513d03

 

[Spock]

I feel actually sorry for people that think in a 1/3 of a second a researched idea of value is erased, yet feel a passive approach to world wide investing in a markets where accounting standards are minimal and bribery is a way of life will assure their retirement by force of statistical science.


https://www.forbes.com/sites/jwebb/...trading-in-developing-economies/#3718fa513d03

I wasn't saying the 1/3 second advantaged HFT eliminates the value of a researched investment (although front running the trade shaves off of both ends). I was saying the percentage of researched trades to make an efficient market is reduced by the sheer volume of HFT (and blind algo+passive investing).

 

[gamboolman]

Well - sounds like speculation and Market Timing to me.....
Seven Come Eleven
Don't see that Devil

 

[NW-Bound]

I am interested in finding more of these companies and compiling a list to be used as potential candidates for stock picking if we get a continuation of this supposed valuation spread.

So far we have discussed T, F, CVX and GILD

low PE isn't everything though, you want to see a decent market for the product and a manageable debt load (along with good cash flow). You can easily get caught up

in things like Seadrill, which was paying something like a 12% dividend before dropping from $40 to $0.19...

In that vein, I am throwing out some companies here, not necessarily for investment purposes but could be for a discussion on why the P/E disparity exists.

I show both the trailing P/E and forward P/E for you to see what the analysts are projecting for the future. Note that trailing P/Es are listed first, then forward P/Es.

Tech sector:

Company Trailing Forward
Apple 7.51 10.67
Intel 10.86 10.23
Micron 2.63 4.48
Skyworks 10.61 8.24
Applied Material 7.51 7.32


Heavy machinery:

Caterpillar 12.26 9.83
Cummins 9.89 8.54


Steel and Chemical:

Nucor 8.61 8.17
Lyondell Basel 6.38 7.34
Eastman 8.68 7.89


Drug and Biotech sectors

Allergan N/A 8.11
Mylan 22.03 5.33
Celgene 11.21 6.00


Paper, Packaging

International Paper 10.38 7.14
Westrock 14.05 7.54


Automobile:

BorgWarner 8.96 7.44
Delphi 4.31 4.22


And here are the high-flying stocks

Amazon 90.97 55.33
Google 25.70 22.19
Facebook 17.98 17.88
Netflix 88.49 61.45
Visa 33.21 21.11
Eli Lilly 50.22 19.27


What is most interesting is the P/E of the utility sector, which is universally taken to be a safe haven in a recession.

Duke 21.75 17.32
Southern 20.68 14.55
Pacific NW 18.59 17.66
Edison 3.48 17.68
Dominion 21.05 17.14

 

[audreyh1]

Great examples of companies that are "historically" cheap (and with great dividend-to-cost percentages)..

- T (7.25%+ divvy; PE of 5, fwd PE of 7.95 - SERIOUSLY?)

- F (7.6% divvy; PE of 5.15, forward PE of 5.63 - ditto)

- CVX (4.1% divvy; more reasonable PE but under-valued by ~20% per M*)

..the list goes on. You can buy some very good companies for CHEAP nowadays..just avoid the high flying FANG stocks. Totally agree on the "bifurcation" currently in the market..

Actually the FAANG stocks have been brutally beaten down over the past month. Down more than the rest of the market.

 

[audreyh1]

The previously mentioned time like pre 2000 when all value stocks were murdered and dot coms were bid thru the roof is enough of an example that the markets are not always efficient and that value investors were indeed smarter than the collective wisdom of those in the dot coms.

I remember BRK.A falling by almost half and Buffett telling anyone who wanted to sell, to sell to him. There was nothing efficient about that market imo.

Exactly. There have been many, many times when relative stock valuations have made no sense being driven by various manias. I never consider equity markets efficient in the short or medium term. There are huge divergences between stocks and bonds, each predicting a completely different economic outlook.

 

[COcheesehead]

I remember the REIT mispricing of 2000 well - it was the single biggest reason I was able to retire early. My JNJ, PG, ADP, EMR, AFL etc had PEs of 30-50 or more, while top quality REITs I moved into like Chelsea, Simon, Prologis, Avalon Bay etc had P/FFOs of 7-10, paying 6-10% dividends while growing 6-15% annually. Amazing.

Same thing is happening now. I own some REITs with PE’s in the 4-5 range, dividends in the 6-12% range.

 

[target2019]

Duke 21.75 17.32
Southern 20.68 14.55
Pacific NW 18.59 17.66
Edison 3.48 17.68
Dominion 21.05 17.14

On Yahoo Finance, I see this:
SO PE Ratio (TTM) 18.34
DUK PE Ratio (TTM) 20.97
ED PE Ratio (TTM) 15.31

These TTMs are higher than your data. Now what about the forward estimates?

 

[NW-Bound]

Duke 21.75 17.32
Southern 20.68 14.55
Pacific NW 18.59 17.66
Edison 3.48 17.68
Dominion 21.05 17.14

On Yahoo Finance, I see this:
SO PE Ratio (TTM) 18.34
DUK PE Ratio (TTM) 20.97
ED PE Ratio (TTM) 15.31

These TTMs are higher than your data. Now what about the forward estimates?

The numbers in my earlier post came from finviz.com. I am surprised to see Yahoo has different numbers. Somebody's computer did not update his numbers.

So, I went to Schwab, and here are their numbers. Their trailing P/E numbers match that of finviz.

SO 20.68 14.47
DUK 21.75 18.11
ED 3.48 17.79

Again, the first numbers are trailing P/E, while the second are forward P/E. One can expect the forward P/E's to differ slightly, because these are estimates by analysts covering the stocks, and not actual reported earnings.

 

[NW-Bound]

I forgot to mention the numbers for the S&P 500 as of 12/18/2018

S&P 19.60 15.25

So, one can see utilities are richly valued compared to the average, while many tech stocks are dirt cheap, on the basis of trailing as well as forward P/Es.

What is going on?