The Third Pig

5 Things To Be Thankful For In This Market (Part 2)

http://www.brickfinancial.com/thethirdpig/archive/2008/11/5_things_to_be_thankful_for_in_1.html

Posted by Ben Taylor on November 21, 2008 12:56 PM

Many of us may find it hard to be thankful for much in this economy, especially when it comes to our portfolios. From its October 9, 2007 peak of 1565.1, the S&P 500 has been down as much as 52% hitting 752.44 on November 20, 2008. But every cloud has a silver lining. The other day I decided to list a few things to list a few things to be thankful for in this, and most bear markets. Here's #2.

2.     Low P/E Ratios

Last month, I pointed to a Wall Street Journal article by Jason Zweig where he points to a Benjamin Graham measure of valuing the stock market adopted by Yale professor, Robert Shiller. Dubbed the “Graham P/E”, it divides the price of major U.S. stocks by their net earnings averaged over the past 10 years, adjusted for inflation.

At October 24, 2008, when the S&P 500 stood at 876.77 the Graham P/E was 15 (I have included November 20th’s low of 752.44, a Graham P/E of 12.5, represented by the red line), the lowest it had been for nearly 20 years the suggestion being the market was greatly undervalued and investors were acting irrational. However, Chris Carroll a Johns Hopkins Professor of Economics, takes a slightly different position in a recent white paper. He points out the numbers predict a 6% or so rate of return over (grey dot, 8% at the red dot) the next 12 years net of inflation, about the historical average. Hardly the panic many market pundits have talked about.

Source: Chris Campbell/Benjamin Taylor

Whether the current market provides for the buying opportunity of a lifetime or simply a return to normalcy as Carroll suggests is of little concern to me. I am finding quality companies at P/E multiples never available before. One company that fits the bill is Coach (COH), the leader in the handbag and accessory market.

 Since being spun off from Sara Lee almost a decade ago, Coach has grown its tangible book value by 49% per year and has not seen its return on equity dip below 40% in seven years. The company has raised its earnings per share by 47% per year and year-over-year EPS has increased every quarter for the at least the last five years including its most recent. Coach also has nearly $410 million in cash with only $2.2 million in debt.

In any other environment Coach would be selling for 25-30x earnings and has since it went public years ago. But today an investor can have Coach for a cool 8x earnings. I must agree with Warren Buffett when he says,

“…fears regarding the long-term prosperity of the nation’s many sound companies make no sense. These businesses will indeed suffer earnings hiccups, as they always have. But most major companies will be setting new profit records 5, 10 and 20 years from now.”

Disclosure: I do not, nor the clients of Brick Financial Mangement, LLC, hold any positions in the companies mentioned but positions may change at any time.

Posted by Ben Taylor on November 21, 2008 12:56 PM

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