C
Cut-Throat
Guest
I am not troubled by this, anymore than you may be troubled with another's $400,000 loss.
How Expensive is the S&P, Really
- Thread starter Craig
- Start date
I am not troubled by this, anymore than you may be troubled with another's $400,000 loss.
haha
Give me a museum and I'll fill it. (Picasso) Give me a forum ...
Last comment here. While I am not exactly troubled by someone else's loss, I do think that the idea of prudence is somewhat under-represented here. Many of us are very confident in our decisions and positions. There may be others who have plenty money, but less experience or understanding. They may want to see various viewpoints. There is a degree of altruistic sharing that goes with a good board.
I don't want to change anyone's mind. I don't need agreement. Not exactly true-I want people to agree 2 years hence with the POV that I am acting on today.
In any case, I personally am unlikely to be unhorsed by any financial event that wouldn't severely stress the whole system.
M
I don't want to change anyone's mind. I don't need agreement. Not exactly true-I want people to agree 2 years hence with the POV that I am acting on today.
In any case, I personally am unlikely to be unhorsed by any financial event that wouldn't severely stress the whole system.
M
cute fuzzy bunny
Give me a museum and I'll fill it. (Picasso) Give me a forum ...
- SG said:Well you can't blame me for not understanding. It's so out of character for you to be less than serious on the boards.
I'm wiggling my butt with a fishcake on my head and blowing milk out my nose right now.
Better do a little ululating and throw out a couple of "death to america!"'s while you're doing that, and involve a dryer sheet somehow. Just dont tell us how you're using the dryer sheet please.
cute fuzzy bunny
Give me a museum and I'll fill it. (Picasso) Give me a forum ...
HaHa said:
Agreed. I just see a bit of bipolarism going on. A lot of folks go with the 'buy indexes, history says xyz and we will all be good'. History also says a lot of other things about where indexes go when they're valued like this. As you mentioned mikey...er...ha ha...we should be around 750-850. But as you also mention, we'll probably go well below that if and when we take that dive.
Theres another alternative...we go sideways for 10-15 years.
Or 'somethings different now' and valuations will remain painfully high and the market will continue to tick upwards. Of course, if somethings different now, then all that other conventional wisdom is just about as good for chucking out the window.
Its that "history says abc and xyz, I'll take the abc and pretend the xyz isnt going to happen" that makes me enter these debates. I want to know where the decoupling takes place.
I'm with the unclemick camp...high dividend stocks. I diverge by holding a fair bit of managed funds with good track records through rough patches instead of indexes.
But I hope its all goofy and everything works out great for everybody.
unclemick
Give me a museum and I'll fill it. (Picasso) Give me a forum ...
Hmmmm
Perhaps - another way of stating the obvious is - once you step off into ER - how ya gonna play defense. In my case - not having to tap IRA in the first 12 years and getting to old age(62 this year) with SS available plus a small non cola pension that kicked in at 55 - I suspect my defense is different than others. I played with a 73-74 type drop on some old calculators to try and visualize worst case. Now I periodically noodle with a simple 50 - 60% stock drop and low interest rates to try and get a handle on how bad income would be dented. I am presuming some durability of dividends.
Without getting to take out land and the infamous S_ _ - I do putz with some worst case senarios from time to time - to test my nerves - so to speak.
Lifestrategy mod(quasi 60/40) might be leading with your chin for someone else - but it's my no 4 dark horse behind: pension, dividend stocks, SS. And 2.5% as Norwegian widow dividends could be extracted in the stretch.
Set up your defense with the players you gots. Notice - I have no real estate - except for a !0% REIT Index which I'm tending to lump with dividend stocks.
Perhaps - another way of stating the obvious is - once you step off into ER - how ya gonna play defense. In my case - not having to tap IRA in the first 12 years and getting to old age(62 this year) with SS available plus a small non cola pension that kicked in at 55 - I suspect my defense is different than others. I played with a 73-74 type drop on some old calculators to try and visualize worst case. Now I periodically noodle with a simple 50 - 60% stock drop and low interest rates to try and get a handle on how bad income would be dented. I am presuming some durability of dividends.
Without getting to take out land and the infamous S_ _ - I do putz with some worst case senarios from time to time - to test my nerves - so to speak.
Lifestrategy mod(quasi 60/40) might be leading with your chin for someone else - but it's my no 4 dark horse behind: pension, dividend stocks, SS. And 2.5% as Norwegian widow dividends could be extracted in the stretch.
Set up your defense with the players you gots. Notice - I have no real estate - except for a !0% REIT Index which I'm tending to lump with dividend stocks.
cute fuzzy bunny
Give me a museum and I'll fill it. (Picasso) Give me a forum ...
If history doesnt repeat itself, all these index investors are in for a lot of trouble.
So are equity investors.
I guess the good and bad news is history most certainly does repeat itself. Its that dang timing thing that nobody can get right. And sometimes when its drunk it keeps going up until nobody listens to the folks who are ringing the alarm bell. And when its hungover sometimes it keeps dropping until everyone is too scared to buy in. Sometimes it doesnt get either drunk or hungover, and just sits there a long time.
Dividends pay, baby.
So are equity investors.
I guess the good and bad news is history most certainly does repeat itself. Its that dang timing thing that nobody can get right. And sometimes when its drunk it keeps going up until nobody listens to the folks who are ringing the alarm bell. And when its hungover sometimes it keeps dropping until everyone is too scared to buy in. Sometimes it doesnt get either drunk or hungover, and just sits there a long time.
Dividends pay, baby.
Thanks Ha Ha, and to all, this thread has been a good one.
But one thing I do admit, this board has scared the crap out of me at times. And my investments show it! I've gone from "oooh, high tech, growth, and aggresive growth funds, pick a couple individual high risk stocks, ta da, diversified!" to "Wellington! Vanguard Value Vipers! Only 20% in S&P index because sky is falling! Foriegn and small cap in hopes of some return! Give me my dividends!" I hope this works out for the better.
But one thing I do admit, this board has scared the crap out of me at times. And my investments show it! I've gone from "oooh, high tech, growth, and aggresive growth funds, pick a couple individual high risk stocks, ta da, diversified!" to "Wellington! Vanguard Value Vipers! Only 20% in S&P index because sky is falling! Foriegn and small cap in hopes of some return! Give me my dividends!" I hope this works out for the better.
cute fuzzy bunny
Give me a museum and I'll fill it. (Picasso) Give me a forum ...
Well if nothing else Laurence, while you may not reach the sky while your toes are still touching the ground, but you wont burn to a crisp either...
Is the S&P overvalued?
It depends.
It depends on how you evaluate value. Mr. Market is always right. So, tomorrow’s Market Value which will be marked to market at 4:00 PM will be neither overvalued or undervalued. It’s what Mr. Market is willing to pay for those assets at 4:00PM. Market Value is what it is. If you’re happy with Mr. Market’s valuation of these assets then buy them at that price, hold them in your portfolio and sleep well at night.
If you evaluate value by LOOKING BACKWARD over time and comparing Mr. Market’s market value against historical experience and traditional financial ratio analysis, you are probably a little concerned right now. You are asking: What gives, Mr. Market? Your ratios look a little out of whack. Bulls say-- no worries, things have changed, this time it’s different. The historical valuation measures aren’t applicable anymore. It’s a brave new wonderful world. Trees, the economy, corporate earnings, dividends, and stock prices CAN grow to the sky. See Larry Kudlow for all the reasons why. Bears say—this atypical, aberrant market valuation can’t last, it never has and things aren’t going to be different this time. A day of reckoning is coming. Takes your pick.
If you attempt to measure the stock market’s INTRINSIC VALUE as opposed to Mr. Market’s daily Market Value then you have a little work to do. And nobody can do this work for you. This is where folks on this Board start to get headaches and spots flashing before their eyes. Here is how Benjamin Graham distinguished the two measures:
“A general definition of intrinsic value would be “that value which is justified by he facts, e.g., assets, earnings, dividends, definite prospects, including the factor of management.” The primary objective in using the adjective “intrinsic” is to emphasize the distinction between value and current market price, but not to invest this “value” with an aura of permanence. In truth, the computed intrinsic value is likely to change from year to year, as the various factors governing that value are modified. But in most cases intrinsic value changes less rapidly and drastically than market price, and the investor usually has the opportunity to profit from any wide discrepancy between the current price and the intrinsic value as determined at the same time.”
What does computing this FORWARD LOOKING intrinsic value entail? What it involves, basically, for ANY asset is estimating the future revenues attributable to that asset, determining an appropriate capitalization rate, then finding the present value of the future income. This is an entirely SUBJECTIVE and PERSONAL computation. The inputs are yours and yours alone.
We have discussed the Dividend Discount Model and the Gordon Equation ad nauseam on this Board, really to no avail. Generates too many headaches. Suffice it to say that I concur with TH’s assessment that the intrinsic value of the S&P, given any rational set of earnings and dividend growth inputs and a reasonable personal capitalization rate yields an intrinsic value south of 800 rather than the 1200 Market Value which Mr. Market places on the S&P today. That doesn’t mean that Mr. Market is going to come to his senses anytime soon and mark-to-market at 800 tomorrow at 4:00 PM. What it does suggest to me is that Ben Graham, in looking for an opportunity to profit from any wide discrepancy between the current market value as determined tomorrow at 4:00PM and the intrinsic value would most likely be shorting this market. He almost certainly would not be DCA’ing into S&P 500 index fund. So what accounts for this large 50%+ premium to intrinsic value which we perceive to be baked into today’s Market Value? Greenspan called it ”irrational exuberance” back in 1996. Others call it “Animal Spirits”. Many financial texts, in addressing the concept of Total Return refer to it simply as “Gains”. Now, I will grant you that the daily Market Value may never reflect intrinsic value and may always contain a premium for exuberance. We are Americans, after all. But I will reiterate what I have said in another post –do you really want to pay for somebody else’s Animal Spirit? Or, more precisely, how much Animal Spirit are you willing to pay for?
One of my favorite Warren Buffet sayings is: in the short run the market is a voting machine – in the long run the market is a weighing machine. The short run is dominated by psychology, investor sentiment, momentum, daily headlines and, yes, volatile swings between fear and greed. In the short run all of these factors are combining to give a thumbs up vote on the market at present. I believe the long run is ultimately going to reflect the weight of the fundamentals, the intrinsic values, a la Ben Graham. Those fundamentals are not flashing an encouraging signal to the DCA buy and holders at this point in market history.
Just my take.
Donner
It depends.
It depends on how you evaluate value. Mr. Market is always right. So, tomorrow’s Market Value which will be marked to market at 4:00 PM will be neither overvalued or undervalued. It’s what Mr. Market is willing to pay for those assets at 4:00PM. Market Value is what it is. If you’re happy with Mr. Market’s valuation of these assets then buy them at that price, hold them in your portfolio and sleep well at night.
If you evaluate value by LOOKING BACKWARD over time and comparing Mr. Market’s market value against historical experience and traditional financial ratio analysis, you are probably a little concerned right now. You are asking: What gives, Mr. Market? Your ratios look a little out of whack. Bulls say-- no worries, things have changed, this time it’s different. The historical valuation measures aren’t applicable anymore. It’s a brave new wonderful world. Trees, the economy, corporate earnings, dividends, and stock prices CAN grow to the sky. See Larry Kudlow for all the reasons why. Bears say—this atypical, aberrant market valuation can’t last, it never has and things aren’t going to be different this time. A day of reckoning is coming. Takes your pick.
If you attempt to measure the stock market’s INTRINSIC VALUE as opposed to Mr. Market’s daily Market Value then you have a little work to do. And nobody can do this work for you. This is where folks on this Board start to get headaches and spots flashing before their eyes. Here is how Benjamin Graham distinguished the two measures:
“A general definition of intrinsic value would be “that value which is justified by he facts, e.g., assets, earnings, dividends, definite prospects, including the factor of management.” The primary objective in using the adjective “intrinsic” is to emphasize the distinction between value and current market price, but not to invest this “value” with an aura of permanence. In truth, the computed intrinsic value is likely to change from year to year, as the various factors governing that value are modified. But in most cases intrinsic value changes less rapidly and drastically than market price, and the investor usually has the opportunity to profit from any wide discrepancy between the current price and the intrinsic value as determined at the same time.”
What does computing this FORWARD LOOKING intrinsic value entail? What it involves, basically, for ANY asset is estimating the future revenues attributable to that asset, determining an appropriate capitalization rate, then finding the present value of the future income. This is an entirely SUBJECTIVE and PERSONAL computation. The inputs are yours and yours alone.
We have discussed the Dividend Discount Model and the Gordon Equation ad nauseam on this Board, really to no avail. Generates too many headaches. Suffice it to say that I concur with TH’s assessment that the intrinsic value of the S&P, given any rational set of earnings and dividend growth inputs and a reasonable personal capitalization rate yields an intrinsic value south of 800 rather than the 1200 Market Value which Mr. Market places on the S&P today. That doesn’t mean that Mr. Market is going to come to his senses anytime soon and mark-to-market at 800 tomorrow at 4:00 PM. What it does suggest to me is that Ben Graham, in looking for an opportunity to profit from any wide discrepancy between the current market value as determined tomorrow at 4:00PM and the intrinsic value would most likely be shorting this market. He almost certainly would not be DCA’ing into S&P 500 index fund. So what accounts for this large 50%+ premium to intrinsic value which we perceive to be baked into today’s Market Value? Greenspan called it ”irrational exuberance” back in 1996. Others call it “Animal Spirits”. Many financial texts, in addressing the concept of Total Return refer to it simply as “Gains”. Now, I will grant you that the daily Market Value may never reflect intrinsic value and may always contain a premium for exuberance. We are Americans, after all. But I will reiterate what I have said in another post –do you really want to pay for somebody else’s Animal Spirit? Or, more precisely, how much Animal Spirit are you willing to pay for?
One of my favorite Warren Buffet sayings is: in the short run the market is a voting machine – in the long run the market is a weighing machine. The short run is dominated by psychology, investor sentiment, momentum, daily headlines and, yes, volatile swings between fear and greed. In the short run all of these factors are combining to give a thumbs up vote on the market at present. I believe the long run is ultimately going to reflect the weight of the fundamentals, the intrinsic values, a la Ben Graham. Those fundamentals are not flashing an encouraging signal to the DCA buy and holders at this point in market history.
Just my take.
Donner
C
Cut-Throat
Guest
Well, there is not a lot of Bulls. The market has been flat for 5 years.
Just in case you haven't noticed.
Just in case you haven't noticed.
unclemick
Give me a museum and I'll fill it. (Picasso) Give me a forum ...
Donner - I agree
So I plan to hurry up and do absolutely nothing.
So I plan to hurry up and do absolutely nothing.
This one’s for Grumpy!
WARNING! WARNING! WARNING! WARNING! WARNING!
What follows may cause headaches, migraines, flashing spots before the eyes, dizziness, nausea and stomach aches. Do not proceed unless you have the patience and stomach for crunching lots of numbers. Otherwise, GO BACK BEFORE ITS TOO LATE! SKIP TO ANOTHER THREAD IMMEDIATELY!
For the more adventurous among our members, you , too, can create your own little S&P 500 intrinsic value calculator and stick your own SUBJECTIVE and PERSONAL inputs in there and determine your own S&P intrinsic value. It’s kind of fun.
First, go to the S&P website at this site and click on the 12 month values tab. This will show you what the latest annual S&P earnings and dividends trends are:
http—www2.standardandpoors.com-spf-xls-index-SP500EPSEST.xls.url
Step 1. Looking at the historical trends you will see that the average earnings and dividend growth rates for the past 15 years are 6.77% and 4.03% respectively. These are pretty good jumping off points for analyzing future growth of earnings and dividend and serve as initial input for the model outlined below.
Step 2. So, if these are the growth rates, what base are we growing from? Looking at the S&P data we can see that the S&P organization is estimating 2005 operating earnings and cash dividends of $73.65 and $21.80, respectively. Our little calculator below grows that base over a 29 year period at 6.77% and 4.03%. We will value that stream of earnings in Step 6.
Step 3. Part of valuing the asset is determining the present value today of the market value of the asset at the end of the holding period – in our case our model holds the asset for 29 annual periods and liquidates it at the end of year 29 or the start of year 30. You may have a different holding period. If you are 80 years old it doesn’t make sense assuming a 29 year holding period. If you are 25 years old you may want to assume a longer holding period. But I will be 85 in 2033 and that’s a plenty long enough holding period for me. So use your own personal holding period. I am using the NPV function in the Excel worksheet to calculate the net present values. It’s pretty easy. Just click the function tab on the main menu and follow your nose. Can’t miss. If you don’t do Excel don’t try this at home.
Step 4. Once you’ve grown your earnings and dividends out to the end of your holding period they can be used to determine the value of the asset at that time. How? Just apply your personal P/E or, inversely, your Earnings Yield assumption to the earnings your have projected at the end of your holding period. In the case below, the projected 12 month operating earnings on Dec 31, 2033, when I am 87, will be $461.05. If the P/E ratio is 20, or inversely, the E/P Earnings Yield is .05, then that $461.05 will be valued at $9,221.07 by Mr. Market. Not bad.
Step 5. Ok, so if earnings grow at an average of 6.77% nominal over the next 29 years and the P/E remains at a high 20 times and Mr. Market will put a value of 9221.07 on the S&P on Dec 31, 2033, what should we pay for that future 9221.07 asset today? What’s it worth to us to own that future today? It depends. It depends on your personal capitalization rate. What rate of return do you require to compensate you for the risk that operating earnings of this asset class are not going to grow at 6.77% average over the next 29 years? It’s a volatile earnings stream. What alternative returns are available to you? What kind of return can you get risk free and sleep at night? What kind of premium to that risk free return must you get in order to entice you into investing in an asset that is going to produce an earnings stream that is growing at 6.77% on average, maybe, or maybe not? The little model below applies a 13.1% capitalization rate to the 9221.07 on Dec 31, 2033 value and establishes a current net present value of $259.64. (in the NPV function of Excel just type in 13.1% in the first term of the function and 9221.07 in the year 29 slot and leave the other 28 slots blank). With a required rate of return of 13.1% you should be willing to pay no more than $259.64 for an asset that you won’t get to liquidate until Dec 31, 2033 at $9,221.07.
Step 6. So where is the value in the S&P if you should only be willing to pay $259.64 for the right to liquidate it in 2033? The value, in a discounted earnings valuation model, is in capturing the earnings stream over those 29 annual periods. While you own that asset those earnings are theoretically yours. So what is that stream of earnings covering 29 years worth to you today? You are going to capture $6,183.41 cumulative over that period. Using a 13.1% capitalization rate, you should be willing to pay $944.54 in exchange for the right to capture those earnings growing each year over the holding period. This is calculated using a series of 29 separate present value calculations over the 29 year holding period and cumulating the total value.
Step 7. The intrinsic value to you today determined by discounting and valuing future earnings on the S&P 500, with a 20/1 P/E assumption, a 29 year holding period, a 6.77% earnings growth assumption, and a 13.1% personal capitalization rate is $259.64 for the right to liquidate the asset at the start of year 30 ---PLUS--- $944.54 for the right to capture earnings for 29 years, for a total market value of $1,204.18. This is how I see Mr. Market basically valuing earnings in today’s market.
Step 8. Run through steps 2 through 7 inserting dividends for earnings and the dividend yield for the earnings yield. You will be discounting and valuing an asset on the basis of dividends and not earnings. You will see that Mr. Market applies a far different capitalization rate to dividends than to earnings. S&P dividend streams, though somewhat risky, are viewed by Mr. Market as a much less risky proposition than earnings streams. In fact, Mr. Market says they are not much riskier than risk free Treasury bonds. (if you believe that). Dividend streams are treated and priced more like annuities than risky streams in today’s market environment.
Step 9. If you grow your dividends at 4.0% for 29 years starting from a base of $21.80 then your dividend at Dec 31, 2033 will be $65.37. Using today’s 1.7% dividend yield, Mr. Market would value that $65.37 at $3,845.50. Using a 5.9% capitalization rate for dividends implies that you should be willing to pay no more than $729.39 for the right to liquidate the asset at Dec 31, 2033. Similarly, the dividends you are going to capture in those 29 annual periods will amount to $1,154.67. With a 5.9% capitalization rate you should be willing to pay not more than $468.65 for that dividend stream over that period.
The total market value based on a dividend discount model with these inputs would be $729.39 Plus $468.65 or $1,198.04. This is how I see Mr. Market currently valuing S&P 500 dividend streams.
Summary, Conclusions, And Other Miscellaneous Thoughts Intrinsic value is an entirely subjective and personal concept. The answer is it depends. It depends on what the heck you decide to value and those input assumptions you see below and as described above. Personally, I am very leery of valuing earnings. First, they are volatile as we have seen over the years. Second, as a small, individual investor I am never going to get my hands on those earnings. In theory I own them, but in the real world I don’t control them. Look at Microsoft. No dividends for years and years and years. Bill Gates was finally SHAMED into sharing a little of the wealth with his stockholders. Earnings are a mirage to us little guys. It might make sense for Warren Buffet or Kirk Kerkorian to determine value on the basis of future expected earnings. They can control the company and capture its earnings stream. Its real for them. It’s only theoretical for me. I don’t like establishing an intrinsic value based on the other guy’s inputs or accepting a market value based on what the other guy (or Mr. Market in the entirety) is willing to pay for the asset. I don’t like take it or leave it choices. The S&P is worth 1200 to Warren Buffet, Kirk Kerkorian and Mr. Market based on expected earnings flows and somebody else’s capitalization rates so it ought to be worth 1200 to Donner? I don’t think so.
I feel more comfortable with valuing dividends. It is a more predictable stream and it is actually, really, coming to my pocket. Dividends are cold, hard and real to the little guy. Now look at the assumptions baked into a dividend discount model you need to assume in order to justify a 1200 market value on the S&P. You have a 1.7% dividend yield (historically low and dropping out of sight). You have a 4.0% dividend growth rate. Dividends got out of favor a while back and they may yet get back into favor as a result of tax changes. I think a 4.0% growth rate going forward is doable but optimistic given recent history. Finally, you have a 5.9% capitalization rate. At 4:00PM Friday, the 30 year Treasury Bond was yielding 4.32%. Mr. Market is telling us that, hey, I am only willing to pay you about 160 basis points above what you can get risk free from the U.S. Treasury for the next 30 years. What’s that? Chump change? Dividends may be less volatile than earnings but don’t tell that to GM stockholders. Mr. Market is telling me that my retirement capital is worth chump change. If I up my capitalization rate from the 5.9% Mr. Market is implicitly using to just 8.0%, and leave all the other optimistic inputs the same, then the intrinsic value calculation falls to $775.40. Pretty sensitive, don’t you think? 8.0% nominal and 4.5% real is not too unreasonable for a little guy, is it? The difference between an 8.0% and 5.9% capitalization rate of dividends is the measure of Animal Spirit in the market today. This is a little scarya s it won’t take much change in Mr. Market’s inputs to melt off a considerable portion of today’s market value. Mr. Market is pricing in a very rosy and happy set of assumptions going forward. Let’s hope he’s right.
Donner
Donner’s Little S&P Intrinsic Value Model:
Earnings Dividends
Last 15 Year Avg
Earnings and Div Growth Rate 6.77% 4.03%
Personal Inputs:
Earnings Analysis:
Earnings Yield 0.05
(Inverse of P/E)
Earnings Growth Rate 6.8%
Personal Capitalization Rate 13.1%
Dividend Analysis:
Dividend Yield 1.7%
Dividend Growth Rate 4.0%
Personal Capitalization Rate 5.9%
S&P 500 S&P 500
Earnings Dividends
Year Year Per Share Per Share
1 2005 73.65 21.80
2 2006 78.64 22.67
3 2007 83.96 23.58
4 2008 89.64 24.52
5 2009 95.71 25.50
6 2010 102.19 26.52
7 2011 109.11 27.58
8 2012 116.50 28.69
9 2013 124.38 29.83
10 2014 132.81 31.03
11 2015 141.80 32.27
12 2016 151.40 33.56
13 2017 161.65 34.90
14 2018 172.59 36.30
15 2019 184.27 37.75
16 2020 196.75 39.26
17 2021 210.07 40.83
18 2022 224.29 42.46
19 2023 239.47 44.16
20 2024 255.69 45.93
21 2025 273.00 47.77
22 2026 291.48 49.68
23 2027 311.21 51.66
24 2028 332.28 53.73
25 2029 354.78 55.88
26 2030 378.79 58.12
27 2031 404.44 60.44
28 2032 431.82 62.86
29 2033 461.05 65.37
Earnings Dividends
NPV of Income Stream $944.54 $468.65
Ending Value of Asset $9,221.07 $3,845.40
NPV of Ending Value of Asset $259.64 $729.39
Intrinsic Value of S&P 500--NPV+NPV $1,204.18 $1,198.04
WARNING! WARNING! WARNING! WARNING! WARNING!
What follows may cause headaches, migraines, flashing spots before the eyes, dizziness, nausea and stomach aches. Do not proceed unless you have the patience and stomach for crunching lots of numbers. Otherwise, GO BACK BEFORE ITS TOO LATE! SKIP TO ANOTHER THREAD IMMEDIATELY!
For the more adventurous among our members, you , too, can create your own little S&P 500 intrinsic value calculator and stick your own SUBJECTIVE and PERSONAL inputs in there and determine your own S&P intrinsic value. It’s kind of fun.
First, go to the S&P website at this site and click on the 12 month values tab. This will show you what the latest annual S&P earnings and dividends trends are:
http—www2.standardandpoors.com-spf-xls-index-SP500EPSEST.xls.url
Step 1. Looking at the historical trends you will see that the average earnings and dividend growth rates for the past 15 years are 6.77% and 4.03% respectively. These are pretty good jumping off points for analyzing future growth of earnings and dividend and serve as initial input for the model outlined below.
Step 2. So, if these are the growth rates, what base are we growing from? Looking at the S&P data we can see that the S&P organization is estimating 2005 operating earnings and cash dividends of $73.65 and $21.80, respectively. Our little calculator below grows that base over a 29 year period at 6.77% and 4.03%. We will value that stream of earnings in Step 6.
Step 3. Part of valuing the asset is determining the present value today of the market value of the asset at the end of the holding period – in our case our model holds the asset for 29 annual periods and liquidates it at the end of year 29 or the start of year 30. You may have a different holding period. If you are 80 years old it doesn’t make sense assuming a 29 year holding period. If you are 25 years old you may want to assume a longer holding period. But I will be 85 in 2033 and that’s a plenty long enough holding period for me. So use your own personal holding period. I am using the NPV function in the Excel worksheet to calculate the net present values. It’s pretty easy. Just click the function tab on the main menu and follow your nose. Can’t miss. If you don’t do Excel don’t try this at home.
Step 4. Once you’ve grown your earnings and dividends out to the end of your holding period they can be used to determine the value of the asset at that time. How? Just apply your personal P/E or, inversely, your Earnings Yield assumption to the earnings your have projected at the end of your holding period. In the case below, the projected 12 month operating earnings on Dec 31, 2033, when I am 87, will be $461.05. If the P/E ratio is 20, or inversely, the E/P Earnings Yield is .05, then that $461.05 will be valued at $9,221.07 by Mr. Market. Not bad.
Step 5. Ok, so if earnings grow at an average of 6.77% nominal over the next 29 years and the P/E remains at a high 20 times and Mr. Market will put a value of 9221.07 on the S&P on Dec 31, 2033, what should we pay for that future 9221.07 asset today? What’s it worth to us to own that future today? It depends. It depends on your personal capitalization rate. What rate of return do you require to compensate you for the risk that operating earnings of this asset class are not going to grow at 6.77% average over the next 29 years? It’s a volatile earnings stream. What alternative returns are available to you? What kind of return can you get risk free and sleep at night? What kind of premium to that risk free return must you get in order to entice you into investing in an asset that is going to produce an earnings stream that is growing at 6.77% on average, maybe, or maybe not? The little model below applies a 13.1% capitalization rate to the 9221.07 on Dec 31, 2033 value and establishes a current net present value of $259.64. (in the NPV function of Excel just type in 13.1% in the first term of the function and 9221.07 in the year 29 slot and leave the other 28 slots blank). With a required rate of return of 13.1% you should be willing to pay no more than $259.64 for an asset that you won’t get to liquidate until Dec 31, 2033 at $9,221.07.
Step 6. So where is the value in the S&P if you should only be willing to pay $259.64 for the right to liquidate it in 2033? The value, in a discounted earnings valuation model, is in capturing the earnings stream over those 29 annual periods. While you own that asset those earnings are theoretically yours. So what is that stream of earnings covering 29 years worth to you today? You are going to capture $6,183.41 cumulative over that period. Using a 13.1% capitalization rate, you should be willing to pay $944.54 in exchange for the right to capture those earnings growing each year over the holding period. This is calculated using a series of 29 separate present value calculations over the 29 year holding period and cumulating the total value.
Step 7. The intrinsic value to you today determined by discounting and valuing future earnings on the S&P 500, with a 20/1 P/E assumption, a 29 year holding period, a 6.77% earnings growth assumption, and a 13.1% personal capitalization rate is $259.64 for the right to liquidate the asset at the start of year 30 ---PLUS--- $944.54 for the right to capture earnings for 29 years, for a total market value of $1,204.18. This is how I see Mr. Market basically valuing earnings in today’s market.
Step 8. Run through steps 2 through 7 inserting dividends for earnings and the dividend yield for the earnings yield. You will be discounting and valuing an asset on the basis of dividends and not earnings. You will see that Mr. Market applies a far different capitalization rate to dividends than to earnings. S&P dividend streams, though somewhat risky, are viewed by Mr. Market as a much less risky proposition than earnings streams. In fact, Mr. Market says they are not much riskier than risk free Treasury bonds. (if you believe that). Dividend streams are treated and priced more like annuities than risky streams in today’s market environment.
Step 9. If you grow your dividends at 4.0% for 29 years starting from a base of $21.80 then your dividend at Dec 31, 2033 will be $65.37. Using today’s 1.7% dividend yield, Mr. Market would value that $65.37 at $3,845.50. Using a 5.9% capitalization rate for dividends implies that you should be willing to pay no more than $729.39 for the right to liquidate the asset at Dec 31, 2033. Similarly, the dividends you are going to capture in those 29 annual periods will amount to $1,154.67. With a 5.9% capitalization rate you should be willing to pay not more than $468.65 for that dividend stream over that period.
The total market value based on a dividend discount model with these inputs would be $729.39 Plus $468.65 or $1,198.04. This is how I see Mr. Market currently valuing S&P 500 dividend streams.
Summary, Conclusions, And Other Miscellaneous Thoughts Intrinsic value is an entirely subjective and personal concept. The answer is it depends. It depends on what the heck you decide to value and those input assumptions you see below and as described above. Personally, I am very leery of valuing earnings. First, they are volatile as we have seen over the years. Second, as a small, individual investor I am never going to get my hands on those earnings. In theory I own them, but in the real world I don’t control them. Look at Microsoft. No dividends for years and years and years. Bill Gates was finally SHAMED into sharing a little of the wealth with his stockholders. Earnings are a mirage to us little guys. It might make sense for Warren Buffet or Kirk Kerkorian to determine value on the basis of future expected earnings. They can control the company and capture its earnings stream. Its real for them. It’s only theoretical for me. I don’t like establishing an intrinsic value based on the other guy’s inputs or accepting a market value based on what the other guy (or Mr. Market in the entirety) is willing to pay for the asset. I don’t like take it or leave it choices. The S&P is worth 1200 to Warren Buffet, Kirk Kerkorian and Mr. Market based on expected earnings flows and somebody else’s capitalization rates so it ought to be worth 1200 to Donner? I don’t think so.
I feel more comfortable with valuing dividends. It is a more predictable stream and it is actually, really, coming to my pocket. Dividends are cold, hard and real to the little guy. Now look at the assumptions baked into a dividend discount model you need to assume in order to justify a 1200 market value on the S&P. You have a 1.7% dividend yield (historically low and dropping out of sight). You have a 4.0% dividend growth rate. Dividends got out of favor a while back and they may yet get back into favor as a result of tax changes. I think a 4.0% growth rate going forward is doable but optimistic given recent history. Finally, you have a 5.9% capitalization rate. At 4:00PM Friday, the 30 year Treasury Bond was yielding 4.32%. Mr. Market is telling us that, hey, I am only willing to pay you about 160 basis points above what you can get risk free from the U.S. Treasury for the next 30 years. What’s that? Chump change? Dividends may be less volatile than earnings but don’t tell that to GM stockholders. Mr. Market is telling me that my retirement capital is worth chump change. If I up my capitalization rate from the 5.9% Mr. Market is implicitly using to just 8.0%, and leave all the other optimistic inputs the same, then the intrinsic value calculation falls to $775.40. Pretty sensitive, don’t you think? 8.0% nominal and 4.5% real is not too unreasonable for a little guy, is it? The difference between an 8.0% and 5.9% capitalization rate of dividends is the measure of Animal Spirit in the market today. This is a little scarya s it won’t take much change in Mr. Market’s inputs to melt off a considerable portion of today’s market value. Mr. Market is pricing in a very rosy and happy set of assumptions going forward. Let’s hope he’s right.
Donner
Donner’s Little S&P Intrinsic Value Model:
Earnings Dividends
Last 15 Year Avg
Earnings and Div Growth Rate 6.77% 4.03%
Personal Inputs:
Earnings Analysis:
Earnings Yield 0.05
(Inverse of P/E)
Earnings Growth Rate 6.8%
Personal Capitalization Rate 13.1%
Dividend Analysis:
Dividend Yield 1.7%
Dividend Growth Rate 4.0%
Personal Capitalization Rate 5.9%
S&P 500 S&P 500
Earnings Dividends
Year Year Per Share Per Share
1 2005 73.65 21.80
2 2006 78.64 22.67
3 2007 83.96 23.58
4 2008 89.64 24.52
5 2009 95.71 25.50
6 2010 102.19 26.52
7 2011 109.11 27.58
8 2012 116.50 28.69
9 2013 124.38 29.83
10 2014 132.81 31.03
11 2015 141.80 32.27
12 2016 151.40 33.56
13 2017 161.65 34.90
14 2018 172.59 36.30
15 2019 184.27 37.75
16 2020 196.75 39.26
17 2021 210.07 40.83
18 2022 224.29 42.46
19 2023 239.47 44.16
20 2024 255.69 45.93
21 2025 273.00 47.77
22 2026 291.48 49.68
23 2027 311.21 51.66
24 2028 332.28 53.73
25 2029 354.78 55.88
26 2030 378.79 58.12
27 2031 404.44 60.44
28 2032 431.82 62.86
29 2033 461.05 65.37
Earnings Dividends
NPV of Income Stream $944.54 $468.65
Ending Value of Asset $9,221.07 $3,845.40
NPV of Ending Value of Asset $259.64 $729.39
Intrinsic Value of S&P 500--NPV+NPV $1,204.18 $1,198.04
C
Cut-Throat
Guest
Donner said:
One thing is for sure. No one will ever accuse Donner of just trying to up his post count!
Spanky
Thinks s/he gets paid by the post
S&P 500 is 30% overvalued according to dividend discount model.
cute fuzzy bunny
Give me a museum and I'll fill it. (Picasso) Give me a forum ...
Wellington, Wellesley, vanguard health care.
BigMoneyJim
Thinks s/he gets paid by the post
I decided to take a closer look at my current holdings (all Vanguard funds). I'm not quite as heavy into straight indexed stocks as I thought I was. I have 23% of assets in Wellington, 55% in LifeStrategy Moderate Growth and 6% in the Extended Market (Wilshire 4500 I think), and these hold my current domestic stock. LS Mod is 35% TSM, but it also is 25% Asset Allocation Fund, and at a quick glance it appears to be doing an spot-on impression of Index 500 to the tune of 100% of its assets as of May 31. Odd. But AA has the option of going all-bond or all-cash or any mix at their whim.
So at the moment 19% of my money is in TSM (through LS), 6% is in VEXMX and 14% is in Asset Allocation (through LS) which is currently structured as S&P 500 but subject to change on the manager's whim. Wellington holds domestic stock but is not indexy as far as I know.
All the doom and gloom talk over the past month or so had me wondering if I should change something. I don't expect to shift my current investments, but I may cut back even further on new 401(k) investments and build up a pile of after-tax cash earmarked for a home down payment and/or car replacement. One to five years for each event, probably. A win-win I guess because I'm not market timing, but if investments do pop and inflation goes sideways I'll look smart for building up cash.
For completeness, my portfolio, each # rounded to nearest %:
LifeStrategy Moderate (55%; following %'s are % of total portfolio)
|- 19% TSM
|- 17% Total Bond Index
|- 14% Asset Allocation
|- 6% Total International Index
23% Wellington
13% REIT Index
6% Extended Market
4% Total International Index
REITs are a tad higher than I wanted, but I goofed the transfer and didn't want to pay the redemption fee to fix it. Total Int'l weighting is 10% from standalone fund and LS component. VEXMX is there because I felt overweighted in large cap domestics.
So at the moment 19% of my money is in TSM (through LS), 6% is in VEXMX and 14% is in Asset Allocation (through LS) which is currently structured as S&P 500 but subject to change on the manager's whim. Wellington holds domestic stock but is not indexy as far as I know.
All the doom and gloom talk over the past month or so had me wondering if I should change something. I don't expect to shift my current investments, but I may cut back even further on new 401(k) investments and build up a pile of after-tax cash earmarked for a home down payment and/or car replacement. One to five years for each event, probably. A win-win I guess because I'm not market timing, but if investments do pop and inflation goes sideways I'll look smart for building up cash.
For completeness, my portfolio, each # rounded to nearest %:
LifeStrategy Moderate (55%; following %'s are % of total portfolio)
|- 19% TSM
|- 17% Total Bond Index
|- 14% Asset Allocation
|- 6% Total International Index
23% Wellington
13% REIT Index
6% Extended Market
4% Total International Index
REITs are a tad higher than I wanted, but I goofed the transfer and didn't want to pay the redemption fee to fix it. Total Int'l weighting is 10% from standalone fund and LS component. VEXMX is there because I felt overweighted in large cap domestics.
Spanky
Thinks s/he gets paid by the post
Art said:
Art,
This fund is closed for new investors. You might consider Vanguard Health Care Viper or the Health Care Index Admiral (initial investment is $100K min).
Spanky
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