Isn't it time to sell?

[XMFmoatster]

http://www.multpl.com/

A few weeks ago, Anurag had pointed me to this site when S&P was back then at it’s all time highs. The PE multiple was also peaking around 23. Since then it has risen to a whopping 25.26.

P/E is exactly what it says, Price divided by Earnings. P/E can increase temporarily even when Earnings drop, for e.g. it did in 2008 or 2009 when we had experienced the great recession. There have been few or many other times when P/E has jumped because of steep decline in earnings.

After you discard those times, you still have a brief period in history between 1996 and 1999 when Earnings were rising, and P/E was rising faster and it jumped from approx 22 in 1996 to 29 in 1999.

Having said that, for most of US Stock market history, P/E has not exceeded the current level, and everytime it has neared this level, it has found a way to drop and revert back (or dip below) to/the mean.

Sure this is a stock picker’s board. But it’s also pretty obvious that when the Stock market drops for whatever reason, the baby gets thrown out with the bathwater. Good Saul stocks such as LGIH, SKX, AMZN are also likely to drop if and when the stock market reverts to the mean.

Which brings me to my question? Do you buy my thesis that stock market will soon revert to the mean. Personally, I am talking my book here. Lately, I have liquidated a lot. I understand that the irrational behavior of the stock market can continue in either direction. Currently, that direction is up. It is possible for 25.26 to increase to 30. The music may not stop for few more years. But we know that if history is any guide, it will stop. THIS TIME IS NOT DIFFERENT.

And when it drops, it will be violent (because the level from where it will drop is a historic high).

Normally, its impossible to time the market. For e.g. if the average PE is 16, and the market is at 19, how can you tell whether the PE will contract back to 16 or 15, or jump to 23 or 25? You can’t. You can speculate. But you can’t be sure. However, when valuations are at extremes, you may not be able to pick the peak or bottom, but can be reasonably sure that things will revert back to mean “eventually”.

Just like when valuations are cheap, it’s imperative that a rational investor goes out on a shopping spree, isn’t it also necessary to go sell when the pendulum has swung in the opposite direction?

[Tamhas]

I don’t know why, every time this topic arises, someone points out that there have been substantial changes in GAAP standards such that one can’t really compare the P/E of then with the P/E of now … and yet the discussion keeps coming up again with that fact ignored.

[PaulWBryant]

You subtly but correctly answered your own question:

It is possible for 25.26 to increase to 30. The music may not stop for few more years.

That is exactly why you can’t pull out because it seems like we might be getting close to the top. What if your timing does turn out to be off by a few years? These companies will be worth so much more because they will have had so much time to grow. SHOP might have 8x as much revenue as it does currently. Who knows what the share price will be in a few years? Even if there were a 2008-type pull back, share price might not return to current levels.

It’s not worth taking a chance of missing out on that just because things seem expensive today.

Bear

[captainccs]

Isn’t it time to sell?

Sell what?

Denny Schlesinger

[F1Fun]

…you may not be able to pick the peak or bottom, but can be reasonably sure that things will revert back to mean “eventually”.

Like you said, you can’t predict the peak, you can’t predict the bottom. So why try to time it. You think you are being safe and correct to go to cash now (and you may be), but it actually can be more damaging than staying the course as well.

Imagine you are all safe and all in cash. Then as each year goes by the market keeps rising. You start thinking you made a mistake, you go back into the market. Then the sudden “violent” drop occurs. Instead of being back to the same cash position you had you’re 50% down.

Stock market isn’t for everyone. You need to be OK with periodic drops.

[Tamhas]

Sell what?

Everything, of course, since numbers like this mean there can’t possibly be any good investments.

I know what you think of that sort of thinking!

[anthonyms]

Dunno. I suppose you could sell the stocks that are at 2 standard deviations above your log curves? Certainly take the chance to sell anything where the investment thesis got busted.
Ant

[captainccs]

I know what you think of that sort of thinking!

My wish list of fast growers has about 50 names on it. Eight made new all time highs so far in August. By contrast, the bottom eight are between 43.7 and 77.0% down from their all time high. If you were to go strictly by reversion to the mean you would sell the top eight and load up on the bottom eight. It’s not quite as simple as that. At this time it looks like my ROST will be called away. If so, then I have to decide what to do with the cash. There is no way I’m selling LKQ and AMZN, my other two holding of these top eight.

Of the bottom eight I already own CLB and I have given up on AIRM and TRIP. OII and HFC are in the oil industry and I already have CLB. That leaves FOSL, BKE and CMG. I don’t like CMG so that leaves FOSL and BKE or maybe bulk up some other position I already have.

This kind of thinking makes sense to me, A blanket “sell all” does not. Show me a successful market timer!

**Symbol  Company                               Last   Down %**
LKQ     LKQ Corp.                            35.68     0.0
ROST    Ross Stores, Inc.                    65.06     0.0
TDG     TransDigm Group Inc.                285.41     0.8
MNST    Monster Beverage Corp.              159.45     1.4
PAC     Grupo Aeroportuario del Pacifico    106.67     1.4
AMZN    [Amazon.com](http://Amazon.com), Inc.                    756.98     2.0
MIDD    The Middleby Corp.                  128.87     2.5
MELI    MercadoLibre, Inc.                  167.69     3.5

**Symbol  Company                               Last   Down %**
FOSL    Fossil, Inc.                         31.80    77.0
OII     Oceaneering International, Inc.      29.73    63.6
HFC     HollyFrontier Corp                   27.10    52.4
BKE     The Buckle, Inc.                     28.26    49.6
CMG     Chipotle Mexican Grill, Inc.        388.50    48.7
CLB     Core Laboratories N.V.              117.49    45.7
AIRM    Air Methods Corp.                    33.62    43.8
TRIP    TripAdvisor Inc.                     62.00    43.7

Denny Schlesinger

[XMFBreakerTinker]

Funny how winners keep winning and so on. Stocks are cheap for a reason. You cannot outthink the market. You can only play incongrueties. The market is not perfect, the market acts as a herd, and there are times when there is Fear Uncertainty Doubt (FUD) that is transparently false, and that creates buying opportunities.

Netflix is an example of this. Starbucks is an example of this. Great companies, great brands, huge competitive advantages, each hit the skids and momentum kept driving them into the ground.

Some may say that CMG is one of those now (not so sure about that). CMG is not quite Netflix or Starbucks, but it certainly may qualify within the category.

But otherwise, a cheap stock is “cheap” for a reason. The thing to determine about an “expensive” stock is whether or not it is in a true bubble, and whether or not it has the reverse of FUD running through it.

As Denny spells out, buying losers is generally one of the best ways to have a losing portfolio.

Being smug and making tons of money in a bubble is yet another.

We are not in a bubble now.

So don’t buy a cheap and destroyed stock unless you see a transparently wrong FUD event; so don’t buy an expensive stock if you see a reverse exuberant FUD event that works against its sustainable advantage.

Otherwise, buying winners (vs losers) if that is all you are investing on, is a much better strategy en masse.

I prefer buying great companies and selling them only upon bubble events or reverse transparent FUD circumstances.

No, my kids don’t understand a word I say either.

Tinker

[qazulight]

Which brings me to my question? Do you buy my thesis that stock market will soon revert to the mean. Personally, I am talking my book here. Lately, I have liquidated a lot. I understand that the irrational behavior of the stock market can continue in either direction. Currently, that direction is up. It is possible for 25.26 to increase to 30. The music may not stop for few more years. But we know that if history is any guide, it will stop. THIS TIME IS NOT DIFFERENT.

http://stockcharts.com/freecharts/historical/marketindexes.h…

My Pioneer Fund went up 50 percent, along with the Dow moving from 800 to 1200 in 1981. Should I have sold?

The wealth of the world is increasing at a rate never seen before in human history. Take the time to watch this entertaining and informative video.

https://www.ted.com/talks/hans_and_ola_rosling_how_not_to_be…

How much do you know about the world? Hans Rosling, with his famous charts of global population, health and income data (and an extra-extra-long pointer), demonstrates that you have a high statistical chance of being quite wrong about what you think you know. Play along with his audience quiz — then, from Hans’ son Ola, learn 4 ways to quickly get less ignorant.

Just to cover some obvious things.

We have developed the technology to draw oil and gas out of the ground in many regions of the world and in the process cut the cost of energy by about 50 percent. (Using very long term averages, energy is currently under valued, but it is unlikely to rise to economic hinderance levels.)

We have developed and deployed the technolgy,Gasoline Direct Injection) to increase average fleet fuel milage by almost 20 percent in the last 5 years, the over all fleet fuel milage increase since 2000 is higher than that.

We have developed and deployed battery technology that allows for electric vehicles to be used, and you can even buy them at reasonable prices. (A 2014 Chevy Volt can be had for 17000 dollars.)

We have developed and deployed smart phones and the communications infrustructure to support them worldwide.

We have developed and deployed solar cells that are now pennies on the dollar what they were 10 years ago.

We have developed and deployed Massivily Open On Line Courses to spread knowledge around the world using the smart phones and infrustructure that supports them.

BUT…

The market is a future looking machine.

SO. . .

We are developing materials that allow for lighter stronger everything.

We are developing materials that are incredible thermal insulators.

We are developing materials that are incredible thermal conductors.

We are developing manufacturing processes to make the materials that we developed 5 years ago.

We are deploying fuel cell technology.

We are developing better and better AI using the Big Data we are collecting via the smart phones and the infrustructure that supports them.

Using this data we are deploying self driving cars.

Using the new materials we are developing an evacuated tube transport system.

We are deploying new genetically crafted medical cures.

We are developing new methods of life extension.

That is just the technology, we have made and are making progress in building better societies. (When viewed across the scope of history and across the world.)

Personally, I believe we may have some real unpleasantness starting around 2029, but between now and then we will probably see changes bigger than the changes between WW I and the Great Depression.

I might note. There was a Fidelity Fund in the 1920’s, it mailed postal money orders to distribute dividend despite the lack of banks.

You might consider selling in 2029, but only to buy high quality dividend paying stocks.

Cheers
Qazulight

[Smorgasbord1]

OK, we’re getting way off the original question - at least as I understood it. It’s not about technology advances and it’s not about increases in wealth: It’s about PE ratios.

Historically (well over 100 years), when the overall market’s PE ratio gets too high (as in above 25), a correction happens.

Is this time different? If you think so, let’s hear why.

BTW, no-one’s say to sell everything. In any big overall market correction, some investments hold up better than others.

[SaulR80683]

Hi Huddaman,

There are the changes in GAAP accounting which make earnings look smaller than they did historically. (I hadn’t thought of that until someone mentioned it on this board). That raises the “apparent” PE, and changes the relationship in historical comparisons.

Also there is Amazon which makes up 2%? 5%? I forget what large percent of the S&P market cap, and has a PE of roughly 200, give or take. This raises the “apparent” PE of the S&P also. Remember? The other 499 companies in the S&P whose average PE isn’t really as large as it is with Amazon tacked on.

And Amazon’s market cap keeps rising faster than the rest of the S&P. Which makes the PE rise as well.

Best,

Saul

[SaulR80683]

There are the changes in GAAP accounting which make earnings look smaller than they did historically. (I hadn’t thought of that until someone mentioned it on this board). That raises the “apparent” PE, and changes the relationship in historical comparisons.

Also there is Amazon which makes up 2%? 5%? I forget what large percent of the S&P market cap, and has a PE of roughly 200, give or take. This also raises the “apparent” PE of the S&P. Remember? The other 499 companies in the S&P whose average PE isn’t really as large as it is with Amazon tacked on. And Amazon’s market cap keeps rising faster than the rest of the S&P. Which makes the PE rise as well.

Another thought about the S&P 500: Its PE will depend a lot on its composition at the time you are looking at it. If it has marginally more large old stalwarts (with good earnings but growth of only 2% or 5% per year in revenue) it will have a lower PE as a whole than if it has marginally more tech growth companies with growth in revenues of 25% to 40%, just say.

Now if you are comparing PE’s with 30 years ago, for example, in addition to GAAP changes which reduce reported revenue, and thus increase PE’s, I’d suspect that there is a considerably larger proportion of rapidly growing large tech stocks, like Amazon and SalesForce, in the S&P now than there was then. It will also make decisions based on historical comparisons questionable.

Next, people talk about the S&P hitting new highs as if that was something dangerous. Since its value now is many, many, MANY, times what it was starting out, it has OBVIOUSLY hit new highs many thousands of times over its history, and has kept going up. Why would you insist that this time is different? That this time new highs mean disaster?

Next we hear that this is an old Bull Market and thus is bound to end, is in a bubble, etc. Well this has been a slow, slow recovery from the Great Recession, and this market has climbed a wall of worry, with always the majority of observers worrying about disaster, and never ANYONE saying "The market is going to boom! It’s going to double". Where’s the froth? Where’s the euphoria? Members who post on this board regularly have been predicting the imminent end of this Bull for at least 5 years now, backed up by indices and charts that have said “It’s over. Get into cash!” and the market has continued to creep up.

Finally we’ve had considerable PE compression, not PE expansion. I gave the following examples in my End of May summary (I haven’t updated the numbers, but you’ll get the picture):

Entering 2014, Arista had trailing earnings of 84 cents, now they are $2.61, more than triple. (It had trailing revenue of $361 million, which has now grown to $901 million, two and a half times what it was). It started trading in June 2014 and hit $94.50 during the year. Now it’s at $72.85. How’s that for PE compression, with triple the earnings and a decreased price!?

LGIH started 2014 at $18 and is now at $27, which is up 50%. However earnings have gone from $1.07 to $2.74, up 156%. Trailing revenue has gone from $241 million to $671 million, up 178%. PE has gone from a reasonable 17 to a ridiculous 9.9. Euphoric market???

Eleven months ago, Skechers closed the month at $50. At that point, they had earnings at $1.17 and a PE of 43. Now they are at $30.70 with trailing earnings of $1.84, and a PE under 17. From a PE of 43 to a PE under 17? Now that’s PE compression! (And their earnings were up 75% last quarter!)

PayCom only has two years or so, having IPO’ed in April 2014, at which time it had 4 cents in trailing earnings, now it has 61 cents, up some ridiculous percent over 1,400%. It had $116 million in trailing revenue, now it has $261 million, up 125%. Its PE has dropped from 450 to a somewhat less wild 67. Again, we are seeing PE compression, not expansion.

Shopify had its IPO a year ago in May 2015. In one year its trailing earnings have improved from (-33) cents to (-13) cents, and its trailing revenues have risen 95%. Is the picture better with double the revenue and about a third the loss? Yes!.. Is the price better? No!.. It IPO’ed at $28.00 and is now at $28.57, essentially unchanged. Is that a euphoric, frothy market?

Synchronoss had 2013 earnings of $1.34. Its earnings now are $2.24, up 67%. It finished January 2014 with a price of $34.30. It’s now at $35.70. Its PE has gone from 25.6 to 15.9.

I agree with those who say, sure a correction will come (Heck! One came in February. Anyone remember that?), but it’s better to not try to guess the market, and just enjoy the ride.

Saul

For Knowledgebase for this board,
please go to Post #17774, 17775 and 17776.
We had to post it in three parts this time.

A link to the Knowledgebase is also at the top of the Announcements column
on the right side of every page on this board

[haywool]

Alright, folks !!

You’ve forced me into it. I’ll tell you all the “secret” to investing … that makes people like me a master of success at investing. Here’s the foolproof method used by most investors:

http://www.retro.ms11.net/InvestorMind.gif

Rich (haywool) somewhere on that line

[IanERichards]

Now if you are comparing PE’s with 30 years ago, for example, in addition to GAAP changes which reduce reported revenue, and thus increase PE’s, I’d suspect that there is a considerably larger proportion of rapidly growing large tech stocks, like Amazon and SalesForce, in the S&P now than there was then. It will also make decisions based on historical comparisons questionable.

This is a good point.

Another factor which nobody seems to mention is the effect of interest rates.

http://www.cnbc.com/2016/04/29/buffett-says-dont-put-too-muc…

“Interest rates act on asset values like gravity works on physical matter,” he said. “If you had zero interest rates and you knew you were going to have them forever, stocks should sell at, you know, 100 times earnings or 200 times earnings.”

Buffett acknowledged rates have been lower for longer than most people had expected and that’s pushed investors into the stock market because of the lack of yield elsewhere.

“When interest rates were 15 percent with [Paul] Volcker, you know, it was an enormous gravitational pull on all assets, not just stocks,” Buffett said — referring to a period of time during Volcker’s time as Fed chairman, a post he held from 1979 to 1987. “If you can get 15 percent, it makes the choices way different than if you get zero.”

The fed may be considering some small rise in rates, but this is inconsequential compared to the level of interest rates in times past.

Ian

[F1Fun]

Current top 5 weighted components of the S&P500 as of end of last trading day is…
Apple 3.15%
Microsoft 2.39%
Exxon Mobil 1.94%
Johnson & Johnson 1.75%
Amazon 1.56%
Source: http://slickcharts.com/sp500

S&P500 can be broken down into sectors and the S&P500 Sector PE ratio can be compared to the 30 year Shiller PE ratio of that sector.
The following sectors are below their 30 year average PE: Energy, Industrials, Information Technology.
Source: http://siblisresearch.com/data/cape-ratios-by-sector/

The S&P 500 index is calculated by taking the sum of the adjusted market capitalization of all S&P 500 stocks and then dividing it with an index divisor, which is a proprietary figure developed by Standard & Poor’s.
Index = SUM (market cap all S&P 500 stocks) / DIVISOR
Source: http://www.investopedia.com/ask/answers/040215/what-does-sp-…

I guess if Standard and Poor’s were doing anything fishy with the divisor, like making the market look better or worse as they pleased, people would have raised it up by now.

[F1Fun]

So to Saul’s point, the movement of 1% of the companies in the index (5) impacts 11% of the value of the S&P500 Index.

[qazulight]

Well,

Don’t buy companies with high P/E ratios. Or, then agian maybe you should buy them. Walmart was never a value stock as long as Sam Walton was alive. Today it is. When was the better time to buy, when it had a high P/E ratio in 1985, or today?

My point about the tech was this. There is more wealth in the world, it will be used. Find the people who can use it to make you money and invest with them.

Saul is doing that.

Cheers
Qazulight

[captainccs]

Is this time different? If you think so, let’s hear why.

Bits vs. Atoms!

But it’s not a direct correlation, the market, via supply and demand, reduces the difference. But there is sufficient bias left in favor of Bits to make investing in knowledge better than investing in industry provided you don’t buy at bubble prices.

A second reason that it’s not a direct correlation is that industry is increasingly incorporating knowledge into manufacturing. Last week I was watching a video about the design and construction of the latest class of American nuclear submarines. According to the video it came in cheaper and in less time than a comparable project a few decades earlier and the main driver was the use of computer based CAD-CAM technology, no more paper designs. I was reminded of our use of PERT-CPM (Program Evaluation and Review Techniques - Critical Path Method) in our consulting business back in 1965-75. PERT was developed by GE to build the Polaris launching submarines!

One reason I think Bits vs. Atoms still gives knowledge a large advantage is that value investors are still using 15th century accounting methods made worse by GAAP-CRAP to pick stocks and that includes basing “sell-all” on historic P/E ratios. Businesses are way too complicated to be explained and predicted by accounting.

Denny Schlesinger

[Tamhas]

Is this time different? If you think so, let’s hear why.

My point is not that there is some qualitative difference that makes “this time” different, but that historical P/E is not directly comparable to current P/E because of differences in GAAP. If it is not the same number, you can’t decide about now based on what was true historically.