Too much complacency in the stock market?

jabba42

This one caught my eye:

http://www.marketoracle.co.uk/Article41504.html

dunstonh

It is important to note that you are talking about the US market. Not the UK which is still at a lower level than over a decade ago. So, when an article aimed at US investors talks about 30 year highs, you cannot apply it to other markets which are still some way off decade old highs.

Some markets do seem to be high on price. Others less so. Whether that indicates a crash to come or a period of little or no growth but reliance on dividend is difficult to know in advance. Whether it would be a quick drop and recovery or a more drawn out one is also impossible to say.

more importantly, whether you could time an exit and re-entry and make more than riding through it is the big consideration. Most investors are better off riding through it unless they need the money in the coming years. If they need it in the coming years they should already be reducing their risk.

Reaper

I don't believe there is evidence of a bubble. The U.S. company valuations are on a fairly high PE (Price/Earnings) ratios compared to the rest of the world, but they always have been. Here is a chart of historic PEs for the S&P 500:


Source: http://www.multpl.com/

High? yes
Bubble? No

Radiantsoul

Reaper wrote: »

High? yes
Bubble? No

The main alternative to stock markets is interest bearing assets which are not hugely attractive either.

redbuzzard

Radiantsoul wrote: »

The main alternative to stock markets is interest bearing assets which are not hugely attractive either.

True but that potentially ignores the classic trap of looking at a yield and comparing it with the interest on a savings account.

In 2008 that could have lost you 40% of your capital, and it might (OK, at some point it will) happen again.

Sebastian Lyon (Troy Trojan fame) has just been burbling about there being more downside than upside risk around, and the likelihood of a "correction" at some point on a two or three year time scale.

Clearly no mug, he acknowledges the impossibility of timing but explains his approach of reducing equity exposure when markets rise, and vice versa.

I wouldn't bet on him being wrong.

It doesn't have to be a bubble to drop 40% - just for there to be more sellers than buyers at current prices.

http://goo.gl/qxQ62

Rollinghome

redbuzzard wrote: »

Sebastian Lyon (Troy Trojan fame) has just been burbling about there being more downside than upside risk around, and the likelihood of a "correction" at some point on a two or three year time scale.

Not everyone is a big fan of Alan Sugar but few could deny that to be the survivor he is suggests his judgement may be better than some.

I liked his line from a few years back: "People are always coming to me with this and that and how much money they're gonna make me, and I say to them, yeah, I know all about that, course it's got loads of upside or you wouldn't be telling me all this stuff about it, but what I wanna know is the downside, how much money could it lose me. That's the important bit. Never forget the downside."

merlingrey

Reaper wrote: »

I don't believe there is evidence of a bubble. The U.S. company valuations are on a fairly high PE (Price/Earnings) ratios compared to the rest of the world, but they always have been. Here is a chart of historic PEs for the S&P 500:


Source: http://www.multpl.com/

High? yes
Bubble? No

P/E of what though?

Remember a company can push its P/E down by buying back stock and there has been a lot of stock buy backs.

Companies have just manipulated their P/E ratios down even in falling revenue environment.

So a company could report a higher EPS but you'd have to deduct any buyback to work out if anything has actually changed, you frequently find companies EPS has risen but a bit of research reveals stock buy backs as a main driver.

bowlhead99

So you're saying it is a negative if a company uses its excess cash to reduce the number of shares in issue so that future profits are split between fewer owners, with each remaining share having a proportionately greater entitlement to assets and every pound or dollar of future profits. I'm not sure I follow?

And given that any declared EPS for a financial year is based on the weighted average number of shares in issue during that year, what in particular is being manipulated?

When a company buys back its own share it typically improves the price of the shares for the reasons above (the opposite of dilution). And buying shares cheap can create tangible value for the company when its shares are at a discount to NAV. And the demand-side support in the market may make the shares go up in value or arrest a fall in value. How does this higher price (higher "P") make the P/E lower?

Interested in your views as they seem counterintuitive.

merlingrey

bowlhead99 wrote: »

So you're saying it is a negative if a company uses its excess cash to reduce the number of shares in issue so that future profits are split between fewer owners, with each remaining share having a proportionately greater entitlement to assets and every pound or dollar of future profits. I'm not sure I follow?

And given that any declared EPS for a financial year is based on the weighted average number of shares in issue during that year, what in particular is being manipulated?

When a company buys back its own share it typically improves the price of the shares for the reasons above (the opposite of dilution). And buying shares cheap can create tangible value for the company when its shares are at a discount to NAV. And the demand-side support in the market may make the shares go up in value or arrest a fall in value. How does this higher price (higher "P") make the P/E lower?

Interested in your views as they seem counterintuitive.

Well it's more to do with how markets react, consider the following:

Company A net income £5 million
Shares outstanding 1 million
Shares purchased 100,000



Eps £5.56

Analyst estimate £5.50

Beat analyst estimate by £0.06

---

Company B net income £5 million
Shares outstanding 1 million
Shares purchased 0

EPS £5.00

Analyst estimate £5.50

Earnings missed analyst estimate by £0.50

bowlhead99

merlingrey wrote: »

Well it's more to do with how markets react, consider the following:

Company A net income £5 million
Shares outstanding 1 million
Shares purchased 100,000
Eps £5.56
Analyst estimate £5.50

Beat analyst estimate by £0.06

---

Company B net income £5 million
Shares outstanding 1 million
Shares purchased 0
EPS £5.00
Analyst estimate £5.50

Earnings missed analyst estimate by £0.50

In your example, if Company A's 100k share buyback happened on day one of the financial year, the weighted average number of shares in issue over the year is only 0.9 million and the amount of earnings per share over the course of the year is legitimately £5.56 which is all available for distribution to its 0.9m investors. It is a more valuable company to be invested in, than Company B which could only return £5.00 to each of its (greater number of) shareholders.

If Company A's 100k share buyback happened on the last second of the 365th day of the financial year, the weighted average number of shares in issue is 1 million and consequently it would report £5 per share earnings, which is the same as Company B. It hasn't performed any better than Company B and would not be reported as having done so.

So, there seems to be no great scam?

Company A in my first example has made more money per share off fewer shares to generate the £5m. Having made the £5m on only 900k shares, it might choose to distribute more per share as dividends to utilise its cash. Higher dividends and higher EPS would result in it being valued higher than B. Or alternatively, A might only choose to distribute £4.5m at £5 per share as dividends and keep the balance back to give it resources for future share buybacks. Investors would see that it is not paying any more dividends than B, so might not immediately value it higher on that metric alone. But as it has higher EPS, better dividend cover, and a track record of doing share buybacks (which are tax efficient from an investor's perspective), it would be valued higher in the market, as it should be, because it is making more money per share.

Whereas Company A in the second example has made no more money per share than B over the course of the year, and would not be reported as having a higher EPS. If they have sufficient funds already set aside to do a share buyback, they could do one on day 365, and then their £5 a share dividend to shareholders on the register a couple of months after year end only costs them £4.5m of cash. But each investor still gets 100% of earnings paid out (still 1x dividend cover, like Company and the same dividend per share (£5 a share like Company , and has missed forecasts as bad as Company B (£5 EPS vs £5.50 forecast), so is going to get valued the same as Company B, all other things being equal.

What am I missing? I appreciate that share price movements are all about the market reaction, but what they react to is the data reported by the company in line with consistent accounting standards, and a lot of market participants know what these things mean. Admittedly if someone (like a journalist looking for a story or an inexperienced retail investor) does not understand what an EPS actually represents, they may jump to the wrong conclusions?

Thrugelmir

bowlhead99 wrote: »

And buying shares cheap can create tangible value for the company when its shares are at a discount to NAV.

Shares are priced on future news so are at premium to NAV. Rarely at a discount. Selling a % of a holding at the first sign of bad news is a sound strategy in my book. As more often right than wrong.