Tuesday, March 10, 2009

It's a battle

“Life can only be understood backwards, but it must be lived forwards.”
Soren Kierkegaard

Yesterday, Bloomberg.com published an article opining that Ben Graham would still think that this market is overvalued. The argument is that in bear markets, stocks have traded at less than 10x earnings (10-year trailing average earnings) so they probably will this time as well. My friend Charlie Minter from Comstock funds makes this argument all the time and it puts me on tilt. Charlie bears it up weekly over here.

As follows is a summary of recent earnings revisions for the S&P from the excellent John Maudlin:

  • On February 13, David Rosenberg, Bank of America's North American Economist, recently reduced his 2009 and 2010 S&P 500 operating EPS forecast to $46 (from $56) and $55.50 (from $63), respectively. Mr. Rosenberg is now forecasting an S&P 500 low of 666 based on a 12x multiple of forward (i.e. 2010) earnings.
  • Francois Trahan of ISI Group dropped his S&P 500 earnings forecast from $60 to $45 on February 23. Mr. Trahan used a 13x multiple to forecast a potential market low of 585.
  • On February 26, Goldman Sachs' David Kostin dropped his 2009 and 2010 S&P 500 operating EPS forecast to $40 and $63, respectively, after deducting $23 and $8, respectively, for provisions and write-downs. Mr. Kostin uses a 13.2x multiple of 2010 earnings (pre-write-downs and provisions) to come up with a year-end 2009 S&P 500 target of 940.

That ^^ is bad. No denying it.

If we're doing a 10-year exercise, I'd rather value something I'm going to buy today based on the next 10 years' earnings rather than the trailing 10 years. Trailing earnings are history, not analysis. That being said, I've invested in crappy semiconductor stocks for long enough to have trouble with the idea that with all the information available, stocks will trade at trough multiples on trough earnings again, absent consensus that there is something very much worse looming.

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