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On the last Market Musings, I was writing about Barry Ritholtz’s basket of metrics and how he uses the basket to value the market. I described each metric and what it was. Today, I want to talk about what they mean based on the results Barry showed in “What Metric Should Be Used for Stock Valuations?” The four metrics Barry was talking about were Trailing PE, Forward Consensus, Schiller Cape, and EV/EBITA. As of 2/28/15, all above their averages by 13%, 13%, 68%, and 4%. If you picked one of these metrics you could argue either the bullish or bearish case about the market. The bullish case being that this market still has room to run, BUY BUY BUY, and the bearish case being that this market is peaking and may even be creating a bubble, GET OUT NOW WHILE YOU STILL CAN! But when you look at a basket of metrics you can see that the majority of the four referenced metrics are not as high as the Schiller Cape. The Schiller Cape is being used for the bearish case telling people the market is over priced. The Enterprise value / Earnings Before Interest, Taxes, Depreciation, and Amortization (EV/EBITA) is being used for the bullish case telling people the market is still fairly valued and it has room to run. When you look at the four metrics together they are all positive but they’re all not as positive as the Schiller Cape. If they were all that positive then I’d be in the bearish camp saying this market is overinflated and I imagine Barry Ritholtz would be as well, but the other three metrics are not that positive. They’re actually pretty reasonable.
Which brings us to our main question, what do these metrics mean if they are up or down?
1) Trailing PE: Tells you what the earning per share (EPS) was for the last twelve months. It’s a trailing indicator, but it gives you an indication of what the actual results have been for the past year. That allows you to answer a number of questions. What major events/news happened? How was the business effected? If the trailing pe is down then that means that the company made less per share of its common stock. If the trailing pe is up it means the opposite. We’re looking at the S&P 500, so it’s all the companies inside the S&P 500. As of 2/28/15, this metric is saying that the S&P 500 has a trailing pe 13% above it’s average. It’s companies are earning 13% more per share. These companies have been earning more money over the last twelve months.
2) Forward Consensus: Is the consesus of analyst estimates on the S&P 500, which is created a number of ways depending on the analyst but it should take into effect the consensus of the underlying companies. People look at this metric to get an idea of where the market will go in the future. If this metric is up, it means that analysts believe the market will continue to go up in the near future. If it’s down, analysts believe the market will fall in the near future. As of 2/28/15, this metric is 13% above it’s average meaning analysts believe the S&P 500 will increase in the near future.
3) Schiller Cape: It’s defined as the price divided by the average of ten years of earnings (Moving average), adjusted for inflation. It’s used to assess likely future returns from equities over timescales of 10 to 20 years, with higher than average CAPE values implying lower than average long-term annual average returns. As of 2/28/15, this metric is 68% above average implying lower than average long-term annual average returns.
4) EV/EBITA: An advantage of this multiple is that it is capital structure-neutral, and, therefore, this multiple can be used to directly compare companies with different levels of debt. A low ratio indicates that a company might be undervalued. As of 2/28/15, this metric is 4% above the average meaning the companies in the S&P 500 are not wildly over valued.
There are many metrics out in the markets and I doubt these are the only metrics Barry Ritholtz looks at when he values the S&P 500. These were just used to demonstrate a broader point that it you want to value anything you need to look at more metrics then the one that confirms you argument. It can be much more confusing but it’s better than losing your shirt because one metric was telling you to BUY BUY BUY.
DISCLAIMER! Don’t be an idiot!
This isn’t my recommendation to invest into the current market. You should never take any one persons advice on whether to invest or not invest in the market. Just like Barry Ritholtz’s advice about how to value the market, you should be taking a basket of opinions to form your own opinion on the markets. It’s okay to listen to people who have more experience than you but you should never have blind faith in anyone person. I’ve been following Barry Ritholtz for years and he’s earned my trust but I still wouldn’t invest in anything solely on his opinion only. You’ll need to do that work yourself.
Tips are for waiters.