Actually, I find 1990 valuation very similar to now. When we compare prices, we must cut it down to a basis where it is comparable. If you just look at the stock price purely, for example McDonald’s, it costs USD7.4 in 1990 and USD31.53 in 2006. How do you compare? You have not counted inflation and all other factors. So are you not going to buy just because it costs so much more compared to 1990? That’s total bonkers. Look at the valuation, the price proves valuations are almost the same both in 1990 and 2006. In 1990, it was a time when commodities surged in price too. But I do not know if the level was the same as 2006, it could be the same but don’t just look at the numbers alone, you must be able to bring it back to a basis where it is the same. At that time, things were at the middle of the bull-run – where the run started in 1982 after a flat market for the earlier 17 years – the bull-run lasted till year 2000 where valuations get totally out of controlled. For some businesses like Coke and Pepsico, the bull started running at its fastest pace starting from 1995, it was valued at 15 to 20 times book value and 28 to 63 times earnings. That is so much pressure to put on for future profits to go way up. The thing to learn here for investors is any future gains are always dependent on current valuations.
During the late 90s, investors are valuing the whole market earnings to be much more valuable than the assets combined. For instance, if you expect a 12% annual gain in stock, but the yearly earnings of the business increases only 7%, in the long run, stock prices will adjust this discrepancy bringing back down the annual expectation of 12% to below the actual increase in business earnings. The iron rule here is that the value of an asset, whatever its character, cannot over the long run moves faster than its earnings do. Another thing I yet to check out is if stock prices are growing faster than the GDP. If it does, it makes no sense to invest at all. Someone once told Warren there’re more lawyers than people in New York. Is it possible or logical? It’s an idea that can be possible where people buy into but it is not logical to happen, those who buy the idea are left with a useless piece of idea in time. That’s the same with people who think that profits can be larger than GDP. When you begin to expect the growth component to forever outpace that of the aggregate, you get into problems in math. If GDP is set to grow at about 5 to 7%, it is illogical for the investors as a whole to expect an average of 12% return yearly on stocks. In the short run, on paper, they may be proven right. But in reality, like what happen in 2000, if you do not take home you winnings, you will be proven wrong in the long run.
At today pricing, if there’s a crash, it is just a slight turbulence, and it is not due to the valuation of the stock. The only weighing factor on this is the core prices of commodities being speculated to such madness. In fact, I think it is better for a crash of such nature to happen, i.e. for commodity prices to come way down. No doubt stocks will follow suit but it won’t be a big fall. It will fall but rise again.
Unless, you have a crystal ball on when the market will crash and so on, I always think it is best to buy on value you can reason out and be fair even if it falls through. Here is a few of Warren ideas. Firstly – “If you are an investor, you’re looking on what the asset is going to do, if you are a speculator, you’re commonly focusing on what the price of the object is going to do.” – to which I’m adding, they are timing what the next fool is going to do. If you are going to play game with a lunatic for money, you can’t reasonably guess the madman next move even with the best math model thrown in. Secondly, “If you understood the business perfectly, and the future of the business, you would need very little in the way of a margin of safety.” Thirdly but not least, “We’ve long felt that the only value of stock forecasters is to make fortune-tellers look good…short-term market forecasts are poison and should be kept locked up in a safe place.”
All of these ideas are to be taken and reasoned out together, not just by using one and then based a decision on that single idea alone. Don’t try to be like the man with a hammer where everything looks like a nail. So when you think of everything that is happening coupled with today valuation of this group of businesses, we are not seeing an overly driven market, at least for this core group that is taken. I did not have the opportunity yet to dig into numbers in the early 70s, I’m pretty sure the valuation then was almost same as late 90s. At that time, Warren was totally out of the market because he was out of sync. Here’s an idea he explained in 1969 – “I’m out of steps with present conditions. When the game is no longer played your way, it is only human to say the approach is all wrong, bound to lead to trouble, and so on. On one point, I’m clear. I’ll not abandon a previous approach whose logic I understand - although I find it difficult to apply - even though it may means foregoing large and apparently easy profits to embrace an approach I don’t fully understand, have not practiced successfully, and which possibly could lead to substantial permanent loss of capital.”
Although at the moment, the market as a whole is not rock-bottom cheap, it is also not a totally irrational speculative market. To give an idea on what has happened in the past market bottoms, the PE of stocks was 10 and the dividend yield was 5%. It happened in 1942, 1949, 1974, 1980 and 1982. As of now, we are not close to that yet but though if you are a buy and hold investor in a great company at a fair price, all these really doesn’t matter to you although no doubt you can earn more when you get something at rock-bottom.
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