There Are No True Valuations Today

By Al Thomas

Daily we hear from the “experts” on CNBC-TV and the radio gurus that the way to buy stocks is find value. One man’s Rembrandt is another man’s connect-the-dots and fill in the spaces. Valuation is like beauty. It is in the mind of the beholder.
If valuation is the key to buying stocks then there should be some kind of a formula to determine what is under-valued and over-valued. In every industry there are formulas for standards of performance. For cars we want to know the zero to 60 mph in how many seconds. For soap it has to be 99 and 44/100 percent pure. For alcoholic beverages it could be how long it has been aged. And on and on.

Yet in the stock market we have no hard and fast set of rules by which to judge a company performance. Ah, and there’s the rub! No matter how good a company performance might be it may have no bearing on the price performance of the stock. You can find good companies that are within a sector that is doing poorly and yet one company can be making huge profits and sales, but the stock price is going nowhere. There need not be any correlation.

When in a bull market almost every stock goes up – even the dogs. In a bear market almost every stock goes down – even the best ones. An 18 year bull ended market in 2000 and almost without exception every stock headed for the exit.

Bull and bear markets follow relatively standard patterns of about 16 to 18 years up and 16 to 18 years down and the valuations go right along with them. Owning stocks or especially index funds during the bear periods an investor will be lucky to have broken even at the end of the 32-year cycle not counting any loss to inflation. Cash in the mattress will outperform market returns while the bear is in charge.

During bear times there will be periods when the market will have a nice advance such as the one that is going on now in 2009. These intermediate rises can ultimately bring many investors back into the market only to lose it when the rally is over and true valuation returns.

One valuation measurement for the overall market is the Price/Earnings ratio of the S&P500 Index. The median number for the historic purposes has been around 14 with the P/E for the S&P500 getting as low as 5 or 6. Today it is running about 21 which is considered high. There are other factors to be considered when buying any stock or fund, but the one thing that is most important is to have an exit strategy. Without one former profits will disappear.

No one knows exactly where the top or bottom of a market move will be. Knowing conventional valuations may or may not help buying and selling decisions.

Article taken from here.