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.As we will see when we look at the history of market cycles in the next section, the overall market P/E, based on an index such as the Standard & Poor’s 500 index (S&P 500), gives an indication as to whether stocks in general are over- or undervalued by historical standards.Other Valuation RatiosThe P/E, although the most widely used valuation tool, is not the only one.Among the others are the price-to-sales ratio, which has the advantage that sales are less subject to short-term variability than earnings, and the price-to-book value ratio, which relates the stock price to value of the company’s net assets and is a very rough indication (because assets are depreciated, valued at the lower of cost or market, or otherwise not reflective of liquidation value) of how the stock value relates to the net asset value.Dividend YieldThe P/E’s main limitation, however, is that by relating price to earnings, it ignores dividends.Thus, for our purposes in comparing individual stocks, we would want to look at the stock’s dividend yield.The dividend yield, called simply yield, is the annual dividend divided by the market price (i.e., the latest quarterly dividend multiplied by four).Like the P/E ratio, yield is most meaningful when a company is compared with industry peers.Public utilities, for example, have higher yields as a group than stocks in other industries, where earnings are less predictable.Like P/E, the overall market yield, as represented by an index like the S&P 500, is a useful tool for determining whether stocks in general are over- or undervalued by historical standards.A Caveat Regarding Dividend YieldOne caveat regarding yield: American companies place a high value on the consistency with which they pay out dividends.This is in contrast with companies in the United Kingdom, which routinely raise and lower dividends as earnings vary.An American company would lower or eliminate its quarterly dividend only as a last resort to conserve cash.What this means, ironically, is that a higher than average yield can be a sign of financial problems.Say, for example, XYZ company sells at $100 a share and pays an annual dividend of $3, giving it a yield of 3 percent.Then something happens that will affect corporate earnings adversely, and in reaction to publicity the stock drops to $50.The company, confident the problem can be solved and wishing to preserve its history of consistent dividend payments, keeps the dividend at $3, which has the effect of raising the yield to 6 percent.An investor attracted to the higher yield would be well advised to investigate the earnings problem and make sure it’s not going to result in a lowering of the dividend if the company is forced to conserve cash.Obviously, the point here is that no investment decision is made on the basis of one ratio.The fundamentals of every investment should be analyzed and the company’s financial strength and earnings prospects confirmed.MARKETS AND CYCLESStocks, with the exception of those combining strong fundamentals and high cash dividends, are a long-term investment.There will always be companies that fail, but viable companies, the overwhelming majority of stocks listed on exchanges, grow and become more valuable with time.Economies, markets, and companies, however, are subject to inevitable business cycles, and that is why stocks are inappropriate investments for your short-term goals.If you’re going to need your money in five years, there’s an excellent chance that stocks will be in a down cycle or market correction when you need it.And if you’re depending on capital gains, you should be aware of how long some bear markets have historically lasted.The severest market downturn or bear market in history lasted 10-odd years between the start of the Great Depression and the early 1940s.The second-worst bear market spanned the years 1966 until 1982, during which time the Dow Jones Industrial Average traded between 600 and 1,000 with inflation eating away at its real value all the while.The worst correction of that period began in 1973 and lasted through 1974, when the Dow dropped 45 percent in nominal terms from peak to trough.It then took 10 years for prices to get back to their previous peak (see Figure 5.1).FIGURE 5.1 Secular markets in 100 years of stock market history, 1900-2000.Six years into the current secular bear market, we can see that during the prior century there were three secular bull and three secular bear markets.Remaining invested during each bear market, particularly when adjusted for inflation, was very costly.The current bear market will be no exception.Source: Reprinted by permission from David L.Tice and Associates (www.prudentbear.com).Since the early 1980s and up until 2000, stock prices followed a steep upward trend, but—stocks being stocks—there was a ratchet pattern to the rise.In 1987, a 36 percent correction lasted just under three months.Adjusting for inflation, if you had bought the Dow Jones Industrial Average in 1966, you would have waited until 1995, nearly 30 years, to get your money back.Since 2000, stocks have traded sideways to lower, in some cases sharply lower, as inflation, once again, eats away at their real values.On average, we have had a market setback once every two years in the past 100 years.See why I prefer stocks that provide a return on investment immediately—and in cash?Past Bull Markets and the Bear Markets that Followed ThemIt is interesting to look back at the bull markets of the 1920s and 1960s and the bear markets that followed in the 1930s and 1970s and make comparisons to the bull market of the 1990s and the bear market that is currently underway as this is book is being written in late 2006.In each case, there was supposedly dawning a new era of eternal market gains: the Roaring Twenties, the go-go 1960s with the “ ’tronics” boom and then the (all-weather, one-decision) Nifty Fifty, and recently the so-called new paradigm in the high-tech 1990s.Each featured astronomical multiples having absolutely nothing to do with reality.The 1929 Crash and 1930s bear market saw a 90 percent drop in the Dow Jones Industrial Average in nominal terms.In 1973- 1974 the Dow, as previously noted, dropped 45 percent in nominal terms, but with high inflation factored in, the decline in terms of gold or even consumer prices was also about 90 percent.AVOID THE CURRENT U.S.STOCK MARKETBy historical standards and given the gloomy corporate profits outlook in an environment of high corporate debt and rising interest rates, the Dow Jones Industrial Average is considerably overvalued at late-2006 levels and should be avoided.I say that, even setting aside the imminent prospect of a collapsed dollar and the recession and hyperinflation that would accompany it.Rising interest rates have potential impact on stock prices for a number of reasons.They increase the carrying costs of corporate debt, reducing earnings.Because other companies are experiencing the same pressure on profits, interest rates have the additional effect of lowering sales and revenues.Large corporations with underfunded pension plans are forced by declining stock prices to make additional contributions, thereby impacting profits.So rising interest rates cause multiple contractions.SHORT THE MARKET?It’s not everybody’s cup of tea, but an investor of above-average sophistication might reasonably ask, “If the U.S.stock market is a train wreck waiting to happen, why not just sell it short?” Selling short means selling an asset borrowed from a broker with the anticipation that it be subsequently purchased at a cheaper price and the profit taken to the bank [ Pobierz całość w formacie PDF ]