No, You STILL Haven’t Missed Out

Tuesday, December 28, 2010

Last year I wrote “No, You Haven’t Missed Out” (October 1, 2009). Now, thirteen months later, that message still applies. Although conditions have improved from that more uncertain time, mid-2010’s detour into mega-trend frights (Greece, etc.) reversed investors building interest in US stocks. That detour was beneficial because it restrained US stock prices, allowing them to remain favorably priced.

By focusing on the risk of forest fire, investors overlooked the opportunity from growing trees. As a result, although the stock market is up significantly since I wrote that previous article, company earnings (actual and forecast) also have grown appreciably.

How to examine stock history and valuations

Stocks can rise on a wave of investor interest and optimism. Or they can be carried upward on the back of fundamental improvements. That latter situation has been the primary mover in 2010’s US stock market.

To understand any market’s characteristics, it is important to know how it fits into history – and not just the last year. Stock price cycles can last many years, particularly following a boom or bust period.

A good example: Coca-Cola (KO)

Note: For a long-term look at the DJIA stocks, go to Securities Research Company (SRC) website at You can examine those 30 stock charts for free by clicking in the box at the top right:

Coca-Cola (KO) was a highly favored stock in the mid-1990s, reaching its all-time-high price of almost $89 in 1998. Since then, the stock has fallen and risen many times, but never surpassed that high. However, both earnings and dividends have set new highs regularly throughout the period.

Source: Securities Research Company (SRC)

Note the box in the upper left-hand corner of the 25-year SRC Coca-Cola chart. For the last ten years (the so-called “lost” decade), earnings and dividends each rose about 10% per year. Meanwhile, the stock rose less than 1% per year (add in dividends and the return was just under 2-1/2% per year).

Now for a view of today’s stock market. Note that Coca-Cola’s earnings line finally touched the price line (equal to a price-earnings ratio of 15x). That is a level unseen since 1988. Combined with an attractive dividend yield, Coca-Cola’s valuation became very attractive.

This situation is a common picture among US stocks now. What it means is that risk-aware investors have been willing to buy because stock prices reached a desirable valuation level. In turn, as earnings and dividend growth lift valuations, stock prices keep pace.

Two stages of buying yet to come

Missing from the current market is widespread US stock interest and ownership by individual and institutional investors. When that occurs, stock prices will likely rise faster than fundamentals in two stages:

  1. As US stocks regain acceptance, widening ownership will cause stock prices to rise to more normal valuations
  2. Following, the good stock returns will increase speculative interest, producing additional buying

So… If you are underweighted in US stocks, you haven’t missed out. Do not view the market’s rise as a reason to worry or hold back. Stock prices are well supported by the fundamentals. We have yet to see a return of normal investor US stock ownership, let alone speculative activity.  When optimism finally returns, then we will have to be more careful in what we buy and when.

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John Tobey on Seeking Alpha

Seeking Alpha Certified

December 2010