This time it is different?

If you invest and worry about the move up in the stock market this year you have heard the phrase several times, "this time it is different."   To that we say yes it is different but valuations are valuations and there are reasons for stocks having certain values. Every time the market pros tell you this time is different it is not different.  We have been through at least 5 market downturns and heard there was no limit to the top each time and each time the market pros and market press were wrong.  Valuations are based on nothing more than the cost of money, think US Treasury yields and bank borrowing interest rates.  

Most stocks over almost any time period earn about 8% including dividends, so use that figure for your investing decisions. When stock markets get frothy bond and borrowing interest rates go up and earnings measured as PE multiples go up. Deduct the cost of inflation, say 3%, and you get your real return.  Right now stocks in index funds are the best choice as they are for most investing environments.

The market is trading generally around 17 to 20 times earnings. So what is a fair valuation? We tend to like around 13x to 14x, and consider certain stocks below 12x to have some upside value.  To be fair there are some stocks fairly valued at 30x or above if they are growing quickly, but if you buy those individual stocks at such high valuations you are subject to the one time disappointment in a quarterly earnings which can literally devastate your stock price. So buying individual stocks we suggest sticking with those under 12x.  

The way we come at this valuation model is using the 8% return we noted earlier here.  That means $100 would earn $8 annually or about 12.5 times a stock valued at $100.  Hence a 12.5 Price Earnings multiple. Now stocks have some value over the exact return as owning a company can protect you from inflation since companies can raise prices.  They also have the opportunity to increase their earnings and raise the stock price due to good corporate governance. So good companies can be valued higher at 13X to 15X PE, but beyond that you begin to take on risk.  Thus assuming it is a solid large cap company they should at least be able to return 8% to the owner over time and therefore anything under 12X should be a good value. Stock selection is very important, so if you prefer not to do the homework, buy a index fund and let the averages work for you. 

If you are investing for the long term we once again believe buying a good S&P 500 index fund and supplement with another well managed higher risk stock fund.  Vanguard has many from which to choose, so go there and make some choices. There will be enough stocks in those funds that if one has a bad quarter you will not feel much pain. If you are investing in individual stocks below we will suggest some options. 

We currently trade telecom and insurance stocks, with some selected big bank stocks throw in.  Add in some real estate and selected special situation stocks and beyond that we find it harder and harder to find values.  No you will not get rich quick here, just make good capital gains and nice dividends to pay your bills. Currently Met Life and Aflac offer some good values in insurance.  We like JP Morgan and Citigroup for bank stocks.  BP and Holly Frontier are good values in the oil patch.  AT&T and Verizon offer some good value in telecom. Add in China Mobile too.  National Retail Properties and Realty Income offer a couple of exposures to real estate that are very safe. We find Apple and IBM interesting lower PE tech stocks.  Cisco has some appeal as well.  Lastly if you want something a bit more out on the risk profile try Stifel Nicolaus as a growing financial enterprise.  Sears Holdings remains an interesting risk play to us as well. 

We either own long or own options on any stock mentioned in this posting.