Current Implication of Market Valuation

There’s no denying that the current bull market has caught many professionals and individuals by surprise.  Many are pondering on the sideline as to when and if this bull market will ever end.

Our recent study of market return (Analysis of Long-Term Return from Equity Market) suggested that equity on average will provide a rate of return between 9% – 10%, but one should be caution of the year-to-year fluctuation.  Also, one should make a distinction between the return from the market and return to individual investor.  The ladder tend to be lower due to an error in market timing.  The biggest contributor that will determine your rate of return is the price you pay for any investment (mutual fund, ETF, real estate, or individual stock).  When we look at individual stock, there’s a high correlation between them and the market.  That is, if the market appears to be overvalued and faces downward pressure, it would be difficult for an individual stock to break such trend.

This lead us to our next topic which is the current market valuation.  Where do we currently stand based on historical market valuation?  The data we’ve chosen to present is the data provided by Robert Shiller of Yale University (found here).  While his data set spans far beyond 1950, the inception of S&P 500, we will not be using them since we can’t validate the accuracy of his conversion.

The two key elements of market valuation are price earning ratio (P/E) and dividend yield.  Let use inspect the first element, the P/E ratio.  The current market P/E is 19.  While one may say that the market is expensive, we need historical data to prove such claim.  Based on the data, the market will on average trade between P/E of 18 and 20 thus placing the current state at or near fair value.  The table below indicate frequencies in months that the market trade in specific P/E range.  At P/E of 20, the market is at 78th percentile which statistically imply that there is a 22% chance for the market to continue to advance beyond current level.

P/E Months Cumulative %
6 0 0%
8 52 7%
10 65 15%
12 78 25%
14 72 35%
16 79 45%
18 147 64%
20 110 78%
22 38 83%
24 32 87%
26 18 90%
28 18 92%
30 18 94%
32 10 96%
34 9 97%
36 3 97%
38 3 98%
More 19 100%


Now let us look at dividend yield and its implication.  Current dividend yield is 1.9% which place the current valuation in the 80th percentile (dividend yield has inverse relationship on valuation, higher figure imply lower valuation and vice versa).  As such, there is less than 20% chance of market advancing beyond the current level.

Div Yield Months Cumulative %
1.0% 0 0.00%
1.5% 49 6.33%
2.0% 111 20.67%
2.5% 60 28.42%
3.0% 110 42.64%
3.5% 154 62.53%
4.0% 88 73.90%
4.5% 63 82.04%
5.0% 45 87.86%
5.5% 34 92.25%
6.0% 28 95.87%
6.5% 12 97.42%
7.0% 14 99.22%
>8% 6 100.00%


To sum it all up, the market appears to be trading at or slightly above its fair value.  The market, however, does not simply trade up (or down) to the average then revert course in the opposite direction.  The fact that we have reached a valuation level not seen since the peak of 2007 hardly mean that the market can’t simply continue higher.  Our study simply suggests that the odd of that happening diminish with every single point increase in P/E ratio.  If we have to speculate, we would be incline to say that S&P 500 would reach 25 P/E before starting to taper off.  Even so, one need to understand the historical perspective and statistics of the market before putting their hard earn money to work at this level.

U.S. Dividend Watch List: July 11, 2014

Top Five Watch List Performance Review

In our ongoing review of the NLO Dividend Watch List, we have taken the top five stocks on our list from July 12, 2013 and have checked the performance one year later. The top five companies on that list can be seen in the table below.

Symbol Name 2013 Price 2014 Price % change
IBM IBM 192.07 188.00 -2.1%
CTWS Connecticut Water Service 29.26 32.72 11.8%
NWN Northwest Natural Gas 43.89 46.56 6.1%
SO Southern Company 44.99 44.53 -1.0%
BMO Bank of Montreal 60.52 74.34 22.8%
      Average 7.5%
DJI Dow Jones Industrial 15,464.30 16,943.81 9.6%
SPX S&P 500 1,680.19 1,967.57 17.1%

The top five under performed the market, particularly the S&P 500, by a wide margin. Three of the five companies are utility companies which we know is facing a strong headwind. Surprisingly Connecticut Water (CWT) managed to do relatively well. On the flip side, IBM (IBM) was the worse performer lossing 2%. However, we estimated the company’s fair value to be at roughly $180. So for the stock to trade down from $192 to $188 didn’t surprise us.

U.S. Dividend Watch List: July 11, 2014

The market gave up some ground this week as the S&P 500 lost 0.9%. The earning season kicked off this week so expect more volatility to come. In the mean time, we are seeing a large influx of companies onto out watch list. Our observation is that these stocks are trading in a narrow band within their 52-week range rather than drop down to a more appropriate discount level. The market is currently trading at a large premium at more than 19x so we this alone is a headwind for individual stock to move higher. While we are not suggesting that this bull market is coming to an end, we do feel that a digestion process is much needed for fundamental to catch up to the technical. Below are 31 companies on our watch list. Continue reading

U.S. Dividend Watch List: June 27, 2014

Top Five Watch List Performance Review

In our ongoing review of the NLO Dividend Watch List, we have taken the top five stocks on our list from June 28, 2013 and have checked the performance one year later. The top five companies on that list can be seen in the table below.

Symbol Name 2013 Price 2014 Price % change
CTWS Connecticut Water Service 28.70 34.19 19.1%
NWN Northwest Natural Gas 42.48 47.03 10.7%
IBM IBM 191.11 181.71 -4.9%
CAT Caterpillar 82.49 108.78 31.9%
PM Philip Morris International 86.62 84.85 -2.0%
      Average 10.9%
DJI Dow Jones Industrial 14,909.60 16,851.84 13.0%
SPX S&P 500 1,606.28 1,960.96 22.1%

The top five companies returned an average 10.9%. The first company we highlighted was IBM (IBM) which we believed to be fairly priced. The excerpt below was taken from last year’s post.

The third company, IBM (IBM), make for an interesting potential research.  Recall that Warren Buffett’s Berkshire Hathaway is a major shareholder of the company.  The company’s stock price plunged in mid April, recovered in May, but has given back all of the gain in June.  Because Buffett isn’t bothered by the short-term fluctuation in price, the recent actions means nothing to him.  One may want to note that IBM appears to be fairly priced according to Valueline which stated that this stock trades at roughly 9.5x its cash flow.  With 2013 expected cash flow of $20.35 per share, the stock fair value is $193.  Our valuation model has a fair value of $180 thus leaving virtually no margin of safety on the shares.

At the closing on Friday, IBM closed at $181 which was right on our target.

The second company was Caterpillar (CAT). We were more bullish on the shares and the stock rose more than 30%. Last year we stated the following.

This Dow Jones Industrial component has been in and out of our watch list for several months. This suggest some form of ‘line’ trading on the longer time frame. The stock yields 2.9% with 32% payout ratio. Earning estimates might have hit bottom as consensus now expects the company to earn $6.88 compared to $8.90 in the previous year. Cash flow should remain strong which will help the company retain, if not raise, their dividend payout or buyback shares.

U.S. Dividend Watch List: June 27, 2014

The market was virtually flat for the week. It appears that further consolidation may be needed if the S&P 500 is to break 2,000 mark and the Dow Jones Industrial Average to break the 17,000 level. The number of companies on our watch list remain somewhat elevated at 42 companies which is a sign that market breadth is relatively weak. Below are 42 companies on our list. Continue reading

Transaction Alert

On June 27, 2014, we carried out the following transaction(s) in our partnership:

Continue reading

Gold Stock Indicator: June 27, 2014

Gold and gold stocks had a lot of movement this past week but little to show for it.