Wealth Accumulated

By D J Thomas, a large-cap stock market value investor and financial writer

D J Thomas

Why lower interest rate rises are less toxic for your portfolio

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Image by Elliot Alderson

0.25 or 0.50? These are the numbers getting everyone’s knickers in a twist. The numerical obsession with interest rates is tied to the fact that stocks like low interest rates. The next FOMC meeting is in a few weeks’ time starting 31st January and Federal Reserve Governor Christopher Waller said last Friday “there appears to be little turbulence ahead, so I currently favor a 25-basis point increase at the FOMC’s next meeting.” And it’s not just Waller. Philadelphia Fed President Patrick Harker said in his view “hikes of 25 basis points will be appropriate going forward”. The expectation has been set.

Machine learns like lightening, very very frightening

Google and Alphabet CEO Sundar Pichai is frightened of future internet users turning to AI rather than using its search engine. It’s clear why: Sridhar Ramaswamy from Google’s ad team between 2013 and 2018, said that ChatGPT could prevent ChatGPT users from clicking on links with ads. Ads that generated approximately $208 billion dollars (81% of 2021 revenue). The recent lawsuit filed against Google by a coalition of 8 US states and the Department of Justice accusing them of ‘destroying competition in the ad tech industry’, may prove to be an untimely distraction. The demo version of Google Search with AI chatbot that Google promised by the firm later this year can’t come soon enough for shareholders.

Google needs a lawyer

The US Department of Justice along with eight states is suing Google. But before we get into that, let’s remind ourselves about the staggering worldwide backlash against Google’s dominance: a $2.73 billion fine by the EC in 2017, a $4.3 billion fine by the EU in 2018, a $1.49 billion fine by the EC once again – all for antitrust issues. Historical fines for Google in the US have been nowhere near these figures. This time around, the lawsuit is seeking to divest its advertising businesses as a way of opening up competition in the ad space. Are we about to see the US admonish one of its own corporate children?

Microsoft’s layoffs cost it a packet

Microsoft earned $2.32 per share. The market was expecting $2.29. All good in the hood. Microsoft said it recorded a charge of $1.2 billion for the quarter, $800 million of which related to the job cuts. Oh, there’s also a slowdown in its cloud and business software divisions for 2023 according to the company. “During the pandemic, there was rapid acceleration. I think we’re going to go through a phase today where there is some amount of normalization in demand,” Chief Executive Officer Satya Nadella. Microsoft earnings are important because it’s seen as an example of the wider tech sector, which also happens to have a major influence on the tech-heavy S&P 500. Its slowdown in December coupled with an acknowledgment of a general slowdown in PC sales forecasted for 2023 looks as though the recession is starting to influence forward earnings “In our commercial business we expect business trends that we saw at the end of December to continue” – Amy Hood, Cheif Financial Officer, Microsoft.

UK government likes debt

From £16.7 billion in December 2021, to £27.4 billion in December 2022, the UK government hits record borrowing. Way above expectations of £17.8 billion. Inflation, household energy bills assistance, student loans, and April’s national insurance policy reversal is to blame. A significant proportion of student loans will never be repaid and the government is forced to recognise this under new accounting rules adding to the indebtedness.

Recession in the UK

Two data points: 1) the S&P global CIPS UK flash composite purchasing managers’ index saw the ‘sharpest drop in business activity for two years’. January data highlighted a sustained downturn in UK private sector business activity. The overall rate of decline accelerated to its fastest for two years. “Weaker than expected PMI numbers in January underscore the risk of the UK slipping into recession”, Chris Williamson, chief business economist at S&P Global Market Intelligence. 2) Anna Leach, CBI Deputy Chief Economist, said: there are signs that demand is easing too, with order books weakening sharply, spare capacity in the manufacturing sector rising and the share of firms citing the strength of sales or orders as a potential constraint on output rising to its highest in almost two years.” If the patient is the UK economy, it’s like two doctors coming to more or less the same conclusion.

Boeing’s flying low

A $663 million loss for the fourth quarter and a $5 billion loss for the full year with a loss per share of £1.75 v expected earnings per share of 26 cents. It’s the sixth quarterly loss in a row. “While we have made meaningful progress, challenges remain and we have more work ahead to drive stability in our operations and within the supply chain,” Chief Executive Officer Dave Calhoun. Boeing is betting on a full re-opening in China and the easing of supply-chain issues that slowed the production of aircraft, especially jet engines. As an old-school value investor, I can’t help thinking back to the massive losses Warren Buffett suffered when he went full ham on airline stocks only to sustain huge losses. No thanks.

Tesla’s earnings turn south

You’ll see the headlines: record revenue at Tesla. What you won’t see, at least not as clearly, are earnings of $1.19 per share v $2.52 in the same quarter last year. Or that gross margins are the lowest in five years and operating cash flow is down 29% from last year. Tesla has already begun well-publicised price cuts on its vehicles which helped ramp up orders. Musk is upbeat about Tesla and thinks he can make up to 2 million vehicles this year which he says will all be sold if they can make them fast enough. ‘Twitter is actually an incredibly powerful tool for driving demand for Tesla’ Musk responded when asked if his political rants hurt the firm. He even had the gall to encourage other automakers to make use of Twitter for marketing their own brands. Elon is a well-received businessman here at Wealth Accumulated.

US Fourth quarter GDP down

A weakening housing market and a slowdown in corporate spending reduced fourth quarter GDP to 2.9% from 3.2% in the third quarter. Consumer spending (68% of GDP) increased 2.1%, fuelled largely by consumer debt, even as retail sales declined in December by 1.1%. Are consumers maxed out? Most commentators believe a recession is coming, albeit a mild one despite these numbers.

Diageo

Earnings per share shot up 20% for the firm this week to 100.9p at the half-year stage. The company owns the most enviable portfolio of drinks brands in the world. Baileys, Johnnie Walker, Guinness, Smirnoff, and a suite of Scotch Whiskeys to name a few. Price rises for its products and an increase in consumers drinking its premium brands helped to boost revenue. It, like a lot of the large caps that sell to China, is betting on increased revenue in 2023 when China re-opens.

Intel

Just 10 cents per share and a $664 million net loss in the fourth quarter of 2022. Intel is predicting a net loss of $15 cents per share in the first quarter of 2023. Intel elected not to give full-year guidance for 2023 but did indicate $11 billion in sales in the March quarter, a 40% year-over-year decline. Their customers have a deluge of chips already and need to work through their supply before buying Intel chips again, at least that’s what analysts are saying.

Chevron pumps profits

Putin’s invasion of Ukraine has prompted what will no doubt be eye-watering earnings from the energy sector. Chevron made a record $36.5 billion profit for 2022, more than double the previous year. The $75 billion share buyback program it announced has President Biden calling it a ‘slap in the face’ for Americans coping with the ravages of flooding in California.

Rolls Royce is a burning platform

The CEO of Rolls Royce, Tufan Erginbilgic gave his employees an analogy: when an oil platform in the North Sea is on fire, you need to jump into the volatile and freezing water to survive. That’s what he meant when referring to the firm as a ‘burning platform’. Covid was dismissed as no more than an excuse for what he called the firm’s chronic underperformance. He will likely announce a brutal restructuring following up his tough words with tough action.

Apple: the FAANG that hasn’t culled overhead. Yet.

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Macbook on a wooden table
Apple did not go on the same hiring spree as other FAANGS during the 2020 lockdowns

I remember laying down next to my allotment plot slash community garden during the summer of 2020. There was literally nothing else to do. I was happy with my employer, with my work. There was no reason for me to leave or seek alternative employment. That was not the case for millions of people who began applying for roles at big tech firms with the extra time they had on their hands to re-orientate their working lives.

Amazon ended up hiring 500,000 employees in 2020, and another 310,00 in 2021 to “meet the needs of our customers while ensuring the safety of our employees… [and] investing for customers and employees during these unprecedented times”. Microsoft hired to a less aggressive extent but the real ‘winner’ was Apple who kept the same hiring rates since 2016, notching the lowest percentage increase in headcount among the FAANGS.

This week, Microsoft CEO Satya Nadella said he will be “making changes that will result in the reduction of our overall workforce by 10,000 jobs through the end of FY23 Q3.” The company will sustain a $1.2 billion charge in its Q2 earnings next week “related to severance costs, changes to our hardware portfolio, and the cost of lease consolidation as we create higher density across our workspaces.” Gotta pay off all those employees somehow. Amazon’s Doug Herrington, the company’s worldwide stores chief, said in a memo Wednesday that they will cull 18,000 employees “so we can continue investing in the wide selection, low prices, and fast shipping that our customers love.

Finally, Google and Alphabet’s CEO Sundar Pichai said he took “full responsibility” for announcing 12,000 job cuts and that the company had rapidly expanded headcount in recent years “for a different economic reality than the one we face today.” The perverse nature of capitalism means that these layoffs will prove profitable for shareholders 1-3 years from now. Traders have already jumped into these stocks on the back of them being huge winners over recent years, but the fact is that as a collective and a large component of the S&P 500, they are still repairing the damage that bloat can do to a business. It’s worth keeping an eye on their earnings in 2023 for sure.

Inflation is falling in the UK. Except for food

“Baked beans are up over 50% in a year. Tinned tomatoes from Spain, also up 50%.” Philip de Ternant, a food wholesaler sounds exasperated on the news that inflation ‘fell’ from 10.7% in November to 10.5% for December. But it’s just not food that continues to see a tsunami of price rises whilst the rest of the inflation basket trickles downwards. Airfares, hotels, restaurants. Basically, if you want to sustain yourself whilst having any fun at all, your financial masters have made it impossible.

When’s a good time to FTSE?

Early in my dating life, I would take a girl to places that had tables. That was my sole choice for the date venue. Didn’t matter if it was a pub, cafe, or restaurant. Tables were where the action was in my mind. I could work my magic charming damsels and the table was like a wingman, allowing me to draw closer, squeeze a hand, and of course play footsie. I remember one particular barman of a local who was a family friend was so impressed with my dating skills that he gave me and my girl free drinks all night. That story is in no way connected to whether or not I think the FTSE 100 is trading at a discount to intrinsic value. Which it isn’t, especially as it’s trading near all-time highs. Now is not the time to FTSE.

The Christmas high street numbers ain’t pretty

US retail sales fell 1.1% in December according to fresh data from the Commerce Department. On top of that, wholesale prices measured by the producer prices index dropped 0.5% for December, more than expected 0.1% showing signs that the US economy is slowing down. The Dow ended the day down 600 points in response. The last time PPI dropped by this amount was in April 2020 raising fresh concerns about a recession.

In the UK, December sales fell by a record 5.8% compared with December 2021 as inflation, and in particular energy costs for households have soared over the past 12 months. It’s well known that where sales growth has been recorded, consumers spending more has been down to corporations raising prices due to inflation. This is the vicious cycle that the Fed and central banks around the world want to stop. Their only weapon in this fight is higher interest rates at the risk of destablising the economy.

Stock in focus: Ferrexpo Plc

As with any stock that’s main business is the production of a commodity, the share price can see swings wilder that an Andrew Tate house party. Chill out nothing’s been proven yet. This FTSE 250 producer and exporter of high-grade iron ore pellets to the global steel industry is based in central Ukraine, which explains some of the most recent price extremes. In the fourth quarter of 2022, Ferrexpo produced 0.4 million tonnes of iron ore pellets v 3.1 million tonnes in the same quarter of 2021.

This reduction is primarily due to the loss of electrical power for the majority of the quarter, which was partially restored in late December, in addition to existing constraints relating to Russia’s invasion. As of the date of this release, the Group continues to produce iron ore pellets using one pelletiser line (out of a total of four)… Full year pellet production of 6.1 million tonnes in 2022, down 46% year on year, reflecting operational and logistical constraints throughout 2022 due to the war in Ukraine (2021: 11.2 million tonnes produced).

Trading update, 11th January 2023

I’ve chosen Ferrexpo this week to highlight the effectiveness of the value investing approach I pursue and specifically the difference between a large-cap stock going through a temporary period of unpopularity such as ExxonMobil in 2020 when the price of oil went to -$37 a barrel and Ferrexpo. Both are commodity stocks. But both face or have faced, different problems. The prolonged nature of Russia’s invasion means that Ferrexpo’s problems are not temporary therefore Ferrexpo is not ‘investment grade’, even though it has a PE Ratio of less than 5, iron ore demand (prices) has been increasing, and its earnings have been growing steadily over the past few years. When the conflict in Ukraine looks likely to end is when to revisit Ferrexpo and its prospects for a brighter future.

Is it time to go all-in now that inflation is easing?

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Egg prices exploded 60% higher last year

Traders: ‘I’m going all-in to the market now that CPI (inflation) is declining. But no. We’re still fearful.

Banks: ‘Nope. A recession is coming. A mild one. But a recession nonetheless. Plus we’ve raised our credit loss provision substantially… because… well… the economy is screwed for 2023′

The Fed’s inflation fight

People like Jim Quinn are shelling out upwards of $6 and $7 for a dozen eggs. Quinn has run daytime eatery The Hungry Monkey Café in Newport, Rhode Island, with his wife, Kate, since 2009. As a breakfast and lunch joint, it leans heavily on eggs for the majority of dishes on its menu — and especially for the 15-egg King Kong omelet novelty food challenge at the restaurant. The cost of food is still hard to swallow, but the latest Consumer Price Index shows that those price increases — by and large — are at least growing at slower rates.

We’ve seen a decline in some measures of inflation but we have a lot more work to do, so I expect the [Federal Open Market Committee] will continue raising interest rates to tighten monetary policy

Michelle Bowman, Federal Reserve Governor

Bowman continues: “I expect that once we achieve a sufficiently restrictive federal funds rate, it will need to remain at that level for some time in order to restore price stability, which will in turn help to create conditions that support a sustainably strong labor market”

The business of banking

Recent fourth quarter results from the large-cap banks:

  • Goldman Sachs: earnings of $3.32 per share vs. $5.48 estimate
  • JP Morgan: earnings of $3.57 per share vs. $3.07 estimate
  • Citigroup: earnings of $1.10 a share vs. $1.14 estimate
  • Bank of America: earnings of 85 cents per share vs. 77 estimate
  • Morgan Stanley: earnings of $1.26 per share vs. $1.19
  • Wells Fargo: Earnings: 67 cents a share vs 66 estimate

Credit losses and wage inflation are to blame for Goldman Sachs’ hit to earnings. Here’s a free business tip if you run a bank: do not offer excessive salaries to ‘recruit and maintain talent’, shareholders will not be happy. Citigroup have the lowest PE ratio from this group at 7.07 at the time of publication.

Once a long term loser, always a long term loser

We need to talk about long-term FTSE 100 losers. Just one actually. Ocado (LSE: OCDO).

And to do that we need to take a quick look at the numbers.

*Checks numbers*.

Oh dear.

Is it me or is the only positive aspect of the Ocado business the balance sheet? Speaking of which:

Following our recent successful financing, we now have a strong financial position and ample liquidity to fund the requirements of our existing and expected customer commitments into the mid-term. No additional Group financing will be needed as the business becomes cash flow positive

Tim Steiner, Chief Executive Officer of Ocado Group

Unfortunatly, Steiner uses cash flow v free cash flow because free cash flow has been non-existent at Ocado, oh, for its entire operating history except for 2018. Also cashflow has been positive in the past yet for most of its operating history, Ocado has posted losses.

Ocado isn’t even on my watchlist.

How to use the price-to-earnings ratio to value large-cap stocks

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Man at a desk with phone in hand working on price-to-earnings

If you’re struggling with profitable investing in large-cap stocks, use the price-to-earnings ratio to value large caps to streamline how you actually look for stocks worth investing in.

I’m not forcing you to have a research process, but if you understand what an investment strategy can bring to your investing success, then stick around.

But a word of caution.

The price-to-earnings ratio (PER) is not the holy grail by any stretch, but it certainly makes the job of determining a sense of value for large caps much easier.

And that makes me feel good.

For context, I pursue a large-cap value investing strategy that involves determining what the real-world value of businesses are (intrinsic value) instead of the make-believe values assigned to them by the stock market and its army of commentators.

Pause.

Translation: massive companies like Apple, Microsoft, and ExxonMobil.

Yeah, I buy those.

But only when they’re on sale.

They call it purchasing shares in a business only when they are selling at a discount to its intrinsic value (margin of safety).

I call it a common sense approach to investing.

Wouldn’t you rather determine the actual, real-world value of a business instead of taking tips from an online forum or a talking head from the mainstream media?

The price-to-earnings ratio helps you to get an understanding of the intrinsic (real-world) value of a business AND whether it has a margin of safety (it’s on sale).

Perfect right?

Here’s the best way you can use the price-to-earnings ratio to value large-cap stocks.

How to calculate the price-to-earnings ratio

Before we get to the meat and potatoes, here’s what the PER actually is:

PER = share price, divided by the last reported earnings per share.

The price-to-earnings ratio is a way of appraising the value of a company based on its ability to turn a profit.

Earnings is simply another word for what accountants call net profit, commonly referred to as ‘the bottom line’.

Net profit is all the money a business has made minus the expenses of doing business like rent, taxes, payroll, and insurance.

Earnings per share is the amount of net profit a business has made divided by the number of shares a business has issued to the stock market.

Phew!

Stay with me here because the bottom is that there is no point in you buying stock in a business that does not know how to make a profit.

Yes, there is a slight learning curve to the PER, but if you want back yourself to learn a profitable investing strategy – and you really should back yourself – then you’re already one step closer to successful investing outcomes.

How to value Apple using the price-to-earnings ratio

Apple’s share price as of this post is $148.11 per share:

Macrotrends notes that Apple’s earnings per share over the previous trailing twelve months (earnings from the previous four quarters combined) is $6.11.

One year’s worth of a business’ earnings seems like a pretty good yardstick, right?

Apple’s share price (148.11) divided by its earnings per share (6.11) = a price-to-earnings ratio of (24.24).

Still with me?

Here’s a word of caution.

The pitfalls of the PER and how to deal with them

Many investors despise the price-to-earnings ratio (PER) as a measure of value.

They’ll say things like ‘managements manipulate earnings with accounting gimmicky to make earnings look better than they actually are’.

And they are absolutely correct.

It IS the case that accountants can and do manipulate earnings to make their business look as though it makes more money than it actually does in real life.

Everyone’s a hustler these days.

Also, some businesses are cyclical; their earnings may be extremely low or negative in one year.

In other years earnings may be extremely high.

Cyclical businesses sell ‘non-essential’ goods and services such as Walt Disney (DIS).

Although in my household, a Disney subscription has been essential since 2020.

Here’s an earnings breakdown for Walt Disney from Macrotrends that shows how earnings per share (EPS) can be ‘cyclical’:

10 years of Walt Disney’s annual earnings

Earnings consistency (or lack of) like this makes it difficult to value a company based purely on its earnings from one year to the next.

You’re much better off getting hold of a chart of the historical PER. It will help you to visualise past earnings value and compare it to where a stock is trading today (see below).

The Macrotrends website has historical for Apple as it does for hundreds of stocks.

Its screener is pretty awesome as well.

REVELATION: I hardly ever purchase a large-cap stock more than 20 times earnings.

The higher the price you pay for a stock based on its earnings, the higher the likelihood the stock will collapse in price after you’ve purchased it.

It’s the (value investing) law.

Combining the use of charts with the price-to-earnings ratio

A PER chart will show you where a stock has traded in the past based on its earnings so you can get a sense of where ‘value zones’ are.

Here’s Apple’s PE ratio chart from Finance Charts:

From 4th November 2008 to 25th November 2022

Working from right to left you can easily determine where the PE ratio is (24).

Then as you scan toward the left, you should begin to see that significant troughs at just above 10 times earnings have been the ‘deep value zone’ for Apple over the previous 14 years.

These deep value zones are where Apple stock sold at its cheapest.

Where they had the widest margin of safety between low price to earnings versus its real-world value.

More generally, you can easily determine that a PE ratio significantly below 20 for Apple has been a great place to buy its stock.

So as of the date of this post, Apple stock is too expensive to purchase based on a value investing perspective.

Implementing a value investing strategy with the PER

Just because a share price is too expensive for you to buy at today’s price, doesn’t mean it won’t be at some point in the future.

And this is the very heart of what is means to be a successful value investor: patience.

You can have all the discounted cash flow models and 13F filing reports you want, but without the patience to see a value-based strategy through, it simply will not work out to be a profitable strategy.

You’ll need:

  • patience to wait for the right price
  • patience to do your due diligence on each stock before the purchase
  • patience for the share price to rise in value when bought at a margin of safety, and
  • patience with yourself when, even after conducting extensive research on a business, its share price declines

That’s a lot of patience.

Free-to-use websites like Finviz are a great place to start because they have screeners that quickly list the stocks you want.

the Wealth Accumulated newsletter does the work for you by including updates on large-cap stocks.

Warren Buffett famously said:

If you aren’t thinking about owning a stock for 10 years, don’t even think about owning it for 10 minutes.

Warren Buffett

THAT’S HOW LONG-TERM THE VALUE APPROACH IS.

Thanks for making it to the end.

If you’d like to master the art of large-cap value investing to drive investing results, sign up for the free newsletter and get notified of when the next online course opens.

How to value the S&P 500 like an expert in 3 easy steps

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How to value the S&P 500

Valuing the S&P 500 is integral to successful global large-cap stock market value investing.

It’s one of the first modules we teach in the Value Investor School because the S&P 500 is the most followed and written about stock market index in the world.

That makes it the simplest index in the world to research and invest in.

Just look at the top ten largest stocks by market capitalisation (at the time of writing).

Market capitalisation refers to the total dollar value of ALL the company’s shares combined.

It reads like a who’s who of the most well-known global businesses:

  • Apple (AAPL)
  • Microsoft (MSFT)
  • Amazon (AMZN)
  • Tesla (TSLA)
  • Alphabet Class A (GOOGL)
  • Alphabet Class C (GOOG)
  • Berkshire Hathaway Class B (BRK.B)
  • UnitedHealth Group (UNH)
  • Johnson & Johnson (JNJ)
  • Exxon Mobil (XOM)

The top five of these stocks represent 20% of the total value of the S&P 500 and some of these names are in the financial press on a daily basis.

So it pays to get to grips with the value of the S&P 500 on a regular basis to either invest in it directly with an index fund or to get a sense of general market valuation.

The importance of valuing the S&P 500 from a value investing perspective

Type the words stock market into your browser or favoured social media channels and you’re bombarded with a thousand opinions on what you should or should do with your money. Sometimes you’ll get stories of the latest stock to collapse in value.

When we come across headlines and news articles from the financial press, they almost always sensationalise the truth as to what is happening to stocks day to day.

How the stock market works in context with macroeconomic events, and how your individual stocks can be affected by rising or declining market values is an important skill set to develop.

The constant wall of noise can be confusing as we’re drawn to seek out ‘expert opinion’ in times of uncertainty whether stocks are rising or falling.

There must be an intellectual safety net out there somewhere.

Luckily, the value approach is an intellectual safety net based on your own balanced, independent research. It is a far better judge as to what to do in any given market scenario than the noise machine from Wall Street.

Financial publications get paid by making you click through to their articles.

Pay yourself first with underpriced value by determining when the S&P 500 is undervalued.

#1 Find out the PE ratio of the S&P 500

A lot of investors balk at the idea of valuing stocks with the PE ratio relegating it to a prehistoric has-been.

The manipulation of earnings by unscrupulous managements and the sometimes lumpy earnings successful businesses produce, yo-yo-ing up and down like no tomorrow, make it difficult to get an accurate valuation of a stock or index based on its earnings.

Or so they say.

Yes, there is also a heavy earnings bias toward the largest capitalised stocks; much of the earnings are concentrated in the top 10 stocks due to their enormous size and global sales.

But I’ve got news for you: nothing is ever perfect in the world of investing.

Successful investors understand that reasoning based on the most accurate information available is better preparation for successful, profitable investing than relying on the opinion of almost everyone.

The number one resource I use for finding out the PE ratio of the S&P 500 is multpl.com, from Rober Shiller, Professor of Economics at Yale University.

When you click through you’ll get a nice chart showing the PE ratio of the S&P 500 from about 1870 to the present day.

#2 Compare the current PE ratio of the S&P 500 to the historical PE ratio of the S&P 500

One thing you’ll notice from the chart is the wild swings in value the S&P 500 has had over the years, especially since the massive liquidity manipulations starting in the 1980s.

Ultimately, your task is to compare the current PE ratio to its historical value.

You do that by noting where the S&P 500 PE ratio is now and where it has bottomed in the past.

The last bottom was in 1980 at 7 and the PE ratio has since made only two major bottoms of 17 in 2006, and 14 in 2011/12.

Put another way, the S&P 500 PE ratio has been bottoming at around 15 over the last 40 years.

Pro tip: on each of those occasions, the Federal Reserve put a floor in and artificially inflated the value of the S&P 500 with quantitative easing and cutting interest rates.

#3 Decide whether the S&P 500 is overvalued, undervalued, or at fair value

For simplicity, I use three gauges of stock market valuation to help them value stocks:

  • Overvalued
  • Fair value
  • Undervalued

You can see why it’s a popular method.

But you can’t get to decide where the S&P 500 is on the value gauge until you’ve done the work and the work tells us that as of the publication of this post, the PE ratio for the S&P 500 is 20 which means it is around fair value.

Why fair value?

Remember the average PE ratio bottom range of 15-17, that is the undervalued range.

It makes sense that 18-20 is fair value range and anything above 20 is overvalued.

Why is 20 overvalued?

Because a rock solid principle of value investing is that we buy stocks and index funds at a discount to intrinsic value (fair value).

One thing to note is that these ranges are not absolutes. They change with economic times such as the recent central bank and government manipulations of stocks since the 1980s.

Ranges play an important role of placing the value of the S&P 500 in context to historical values.

For even greater context, the S&P 500 is heading towards undervalued because the Federal Reserve is in a monetary tightening cycle (raising interest rates and shrinking its balance sheet) and the US is already in a technical recession.

The White House and The Federal Reserve have both tried to redefine what a recession is for political reasons but the truth is that GDP has declined for two back-to-back quarters in a row.

The Federal Reserve also strenuously maintains that rates will rise well into 2023 and well-known financial institutions predicting a global recession in 2023.

Based on the history of how stock market prices perform under similar conditions, the S&P 500 is likely heading lower.

How much lower?

Nobody knows.

That said, you’re job is not to second guess the President, The Federal Reserve, or even where stock prices are heading in the future.

From a value investing perspective, you’re simply defining what the value of the S&P 500 is now whilst taking into consideration the macroeconomic environment of the global stock market.

Publicly available interest rates and GDP data help you with this task.

Over time as you regularly interpret financial markets news flow within the context of a value-first approach, you’ll develop a deeper understanding of how the stock market actually works not from a day-to-day perspective, but from a long-term, low-risk perspective that most market participants do not consider.

You have my permission to take ownership of your own financial success.

Need some help with becoming a smarter investor?

A value-first approach to investing creates a mind free of distractions that’s hard to beat.

Sometimes value investing can still seem bewildering given the never-ending stream of headlines and financial jargon, especially in times of uncertainty.

You may even have struggled with some of the terminology in this post.

That’s okay.

The good news is that you do not have to choose between a financial dictionary and interpreting 1000 opinions a day to become a truly successful, long-term investor.

You can use a value investing framework that respects your time, common sense, and appreciation of what actually matters in financial markets in plain English.

If you want to learn more about making successful value-orientated investments, check out the online stock market investing course.