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How Cheap?


Viking
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I was looking at a few stocks of well run, profitable companies and was surprised by how long they have been trading sideways:

      $ today

KO  $52.41; also traded at this price Nov 1996 = 13.5 years

JNJ  $59.73; also traded at this price Nov 2001 = 9.5 years

MSFT$26.46; also traded at this level June 1998 = 12 years

XOM $60.77; also traded at this level Feb 2005 = 5 years

S&P 500 1,098; also traded at this level March 1998 = 12 years

 

What does this mean? This tells me that many well run companies today offer much better value than they did in years past. We are also in a low interest rate environment which tells me stock averages will likely tend to sport a PE a little higher than average.

 

When I put the two together I wonder if we are not entering a period where we will look back and say that this was a wonderful time to be a buyer (and long term holder) of well run, profitable companies.

 

My style has been to buy low and sell high (normally in the same year). I am wondering now if a buy (sectors that get beat up like big pharma, big oil, insurance/re-insurance) and hold for years is going to be a more profitable and easier strategy to execute moving forward...

 

A good example is FFH. The company is trading today at a decent valuation; I think there is a reasonable chance it will go lower in the short term due to 1.) risk assets selling off (happening) 2.) hurricanes this summer. My plan is to buy on weakness over the next 4 months. Now what happens if the stock does not sell off (perhaps FFH starts buying back shares, which I also expect to happen). Using short term thinking I may miss a great buying opportunity especially given that I am confident that FFH will compound BV growth annually at a 12% to 15% rate for the next few years.

 

Just a little bit of a tug-a-war that has been going on back and forth in my head...

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Hi Viking,

 

I think the defining characteristic is that investors were willing to pay obscene amounts for businesses in the past, thus you have many companies where the valuation tread sideways for years.  In the meantime, these businesses have doubled, tripled or quadrupled their earnings, maintained or grown their market share, and continue to exist as dominant players in their industry. 

 

I think if you are looking at a broad spectrum of the market, then you have better valuations within many of the premium players, when compared to some of the valuations you see in the small to mid-cap spectrum.  That being said, buy what you think is cheap and then sell it when it is dear.  Most investors weren't willing to do that over the last ten years.  Cheers!

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I agree for the most part - especially with the interest rate comment.  I was discussing this on another thread with another member, due to interest rate levels, I think stocks offer much better value today relative to bonds.  I think when you look at the rfr rate in the market (4%) and the implicit spread between the cap rate for stocks over rfr, it is much higher than than in the past.  

 

Essentially, the stock market is priced as if growth is not possible and deflation will most likely occur, and so is the bond market.  Gold is the only asset right now that is priced as if inflation is a reality.  

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I believe you thesis is dependent upon continued growth of these firms and reasonable starting valuations.  As Sanjeev has pointed out the starting valuations were anything but conservative.  For KO, the FCFx is still 20 despite years of sideways growth.  Given the size of these firms, future growth will be harder to come by.  Even looking @ BRK (probably the best run firm), its growth has declined to about 8% per year (over the past 5 to 10yrs) from 20% plus in the past.  The only firm on the list that I think has a sustainable growth rate is JNJ but even then the challenges are large.  Interestingly enough, I still see value in small and mid-cap names from a bottom's-up perspective (FCFx of 2.5 to 6) versus some of these large names where FCFxs are still above 10.

 

Packer

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Things are not silly cheap but in an environment with low yields the growing dividends of the aforementioned companies are going to start to look pretty good. 

 

Take JNJ: 3.5% - my cost to borrow is about 3.75% to 4 %.  If JNJ raises its dividend at 10% per year then in 5 years I will be receiving 6% yield on the dividend.  Now my cost of borrowing will likely rise somewhat but not a lot in an environment with widespread de-leveraging, and high cash loads on corporate balance sheets.  This completely discounts any increase in the stock.  Basically, I could afford to hold these companies for a long time.

 

Same applies to KO for sure.  I dont know the others as well.

 

 

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History does not repeat but it often ryhmes. I have been using a playbook for a long time that what we are seeing unfolding in the worlds capital markets is not dissimilar to what unfolded between 1968 and 1982. By 1968 we had a market that generaly was overbought and overvalued the "NIFTY FIFTY" era drove the valuation of growth stocks to a multi generational high. The low of 1974 drove valuations to a multi generational low. I suspect that the March low of 2009 was the the best we will see I also suspect that we are still a few years away from a similar turning point to the August 1982 low in the mkt which set up the great bull mkt run that continued pretty much unabated till the 2000 top.How long we continue in this sideways trading pattern is largely determined I think by future trends in interest rates and inflation. At least half of the return during the 1982 to 2000 period was driven by the drop in yields and inflation rates and the impact this had on US treasuries. If we are to see an extended period of higher bond yields and higher inflation then this will create a pretty stiff head wind for equity prices overall and cetirus paribus will extend the sideways price movement

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