Financial Mkts, where we are? and where we are going?

... only Bernanke knows

In an environment of (high to) low interest rates, growth companies (valuations) rise.

In an environment of (low to) high interest rates, growth companies decline.

In the current market situation, I think Bonds are poised to a significant fall in the med / long term. Thus, I like value companies more than growth companies.

Favourites among them: big franchise companies who have maintained a good operating margin through time (are price settlers), and have little debt: KO, JNJ, PG, MCD, MRK ...

VALUATION MODELS (PE / EVtoEBITDA / RIM)

PE is the most popular ratio. It is a measure of the price paid for a share relative to the annual net income earned by the firm per share.

It depends on:

- Growth (expected EPS g)

- Risk (Ke)

- Payout ratio (assuming constant growth, therefore ROE)

10y PE used by R. Schiller
Normalized PE used by J. Grantham: Calculate normalized earnings by multiplying a normalized profit margin (avg is 5.5%) by current P/S of the share / index. Apply the PE multiple (from 1900 to 2005, arithmetic avg 14, geometric avg 16)

Normalized PE for the SP500:

Calculate normalized earnings by multiplying a normalized profit margin by sales per share, assume 6% profit growth for the next 20 years – which is the long-term growth rate for earnings – apply a multiple of 15x – which is the long-term average PE of the market – then discount this 20-year expected S&P 500 target back to the present to calculate the expected capital gain. Then add the current dividend yield to get my total expected return. Currently, this model is forecasting a total return to equities over the next 20 years of 6.7%, well below the long-term average of 10%.

Enterprise Multiple (EV/EBITDA) looks at the cash flows before interest expenses.

It is very used by professionals (e.g. LBOs, MBOs, PE), because they could buy the outstanding equity and debt to change the leverage of the firm, and extract more value if possible.

It also leads to lower multiples' values (which is good, looks more attractive to buyers lol:)

RIM ...

would be the perfect valuation measure. Very appealing intellectually.

Takes into consideration the opportunity cost for the shareholders and examines whether the company created value up and above the broad market risk/return trade-off.

Current Valuation by Forward PE:

1. Calculate normalized earnings by multiplying a normalized profit margin by sales per share (P/S)
2. Assume 6% profit growth for the next 20 years – which is the long-term growth rate for earnings
3. Apply a multiple of 15x – which is the long-term average PE of the market
4. Discount this 20-year expected S&P 500 target back to the present to calculate the expected capital gain.
5. Add the current dividend yield to get the total expected return.

... currently, this model is forecasting a total return to equities over the next 20 years of 6.xx%, well below the long-term average of 10%. For how long Bernanke may sustain the house of cards (wealth effect among US consumers) ??