We have updated our Terms of Use.
Please read our new Privacy Statement before continuing.

Cheap chips

29 December 2011 By Robert Cole

It is the oldest saw in the investment handbook: buy low and sell high. But with global shares at their cheapest in a generation, confident equity investors are a rare breed.

Back in 1999, share buyers were everywhere, clambering over themselves for any old variety of equity – and plenty of the new-fangled dot-coms too. Even a sober investor, one that bought a diversified basket of S&P 500 equities, would have got in at a price in excess of 20 times forward earnings. Now the forward PE ratio is just above 11.

Those that bought in the high old times around the turn of the century have not lost as much as might be imagined. Increases in corporate earnings have cushioned the pain caused by the compression of valuation multiples. And dividend payments have bolstered total returns. The all-in value of a portfolio of $1,000 worth of S&P 500 shares acquired at the turn of the century is now just in the black – in nominal terms – despite the intervening crisis.

A new Breakingviews calculator works out what happens if, over the coming years, valuation multiples rise again. Say an investor buys in at 11 times earnings and sells in five years’ time at the 25-year average S&P 500 PE ratio of 15 times. Meanwhile, suppose companies manage to increase their earnings per share at a 5 percent annual rate. Bears might think that is optimistic – and short term it may be. But the longer term earnings trends suggest this is a modest assumption.

Each $1,000 invested now would be worth more than $1,740 in five years. Dividends, currently running at a 2.6 percent yield on the S&P 500, will add an extra fillip. But inflation will reduce the real gain. Assuming 2.5 percent is a reasonable outlook for inflation, that’s roughly a wash with dividends.

Stocks are of course risky. History may not repeat itself. Global banks could fail, currencies could spiral, poverty could descend on the world’s consumers and markets could suffer a long financial winter. But savers confident enough to believe that better times will roll again within a few years should hope the gloom lasts a bit longer yet. It’s a great time to buy equities.

Predictions: Breakingviews is publishing a series of articles over the holiday that look ahead to 2012. The pieces will be collected together in the annual ’Predictions Book’, produced in print and electronic form early in the New Year.

 

Email a friend

Please complete the form below.

Required fields *

*
*
*

(Separate multiple email addresses with commas)