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August, 2017


Is now a good time to buy stocks? That depends. Warren Buffett, CEO of Berkshire Hathaway (BRK/A and BRK/B), probably the most famous, successful, and rich value investor in the world, says the best way of assessing whether the stock market in general is fairly valued, undervalued, or overvalued is by looking at the total U.S. equity market-cap (the combined value of all U.S. stocks, based on today's prices for all shares) divided by the gross federal product. The latter refers to the total value of goods produced and services provided by a country during one year, equal to the gross domestic product plus the net income from foreign investments. When this ratio is high, meaning stock prices are on the whole significantly above the value of goods and services plus foreign investment income, the market is overvalued. If within about 10% above or below, they are likely more or less fairly valued. On the other hand, if the ratio is 0.80 or below, Buffett considers the market undervalued and says this usually is the best circumstance in which to invest in equities (stocks). An approximation of the Buffett value ratio can be obtained by dividing the U.S. market-cap (Wilshire 5000 Full-Cap Price Index) by the gross domestic product (same as the gross federal product except with foreign income excluded).

Per the website, at the beginning of this month the ratio result (129.8) was almost at its highest point in history, second only to its level (136.5) at the end of the dotcom bubble, just prior to big market drops in 2000 and 2002, and substantially higher even than just prior to the 2008 financial meltdown (104.9), which also, of course, saw large stock market losses.

Per the website, which is updated daily, the U.S. stock market is significantly overvalued and, as of 8/19/17, the ratio stood at 130.8. This site also uses the ratio to forecast estimated total returns. It predicts that investments made today will, even including dividends, over the next few years provide the average investor with a lot more losses than gains.

Based on Buffett's preferred way of assessing these things, this is probably not a good time to be doing new investing. Indeed, investors might be better off gradually selling existing holdings to raise cash, against the possibility of buying more shares once the market takes a big hit, as overall it tends to do around every 4 years or so.

Low Price to Value Assets

Featured Value Statistics
AbbVie, Inc.ABBV$69.96Forward P/E 10.80; PEG Ratio 0.91; Dividend 3.66%.
Alliance Bernstein Holding, L.P.*AB$23.10Trailing P/E 10.79; Forward P/E 10.36; Dividend 8.94%; Price to Book Value 1.47.
Amgen, Inc.AMGN$167.29Dividend 2.74%; Price to Free Cash Flow 16.85.
ARRIS International, plcARRS$26.66Forward P/E 9.01; PEG Ratio 0.55; Price to Book Value 0.75; Price to Free Cash Flow 6.12.
Iconix Brand Group, Inc.ICON$5.00Forward P/E 7.58; PEG Ratio 0.51; Price to Book Value 0.76; Price to Sales Ratio 0.81.
ManpowerGroup, Inc.MAN$106.66Price to Sales Ratio 0.36; Price to Free Cash Flow 18.97.
McKesson Corp.MCK$146.00Trailing P/E 6.42; Price to Sales 0.15; Price to Free Cash Flow 9.62.
Rocky Brands, Inc.RCKY$13.85Dividend 3.17%; Price to Book Value 0.76; Price to Sales 0.39.
Steelcase, Inc.SCS$12.95Forward P/E 11.36; Dividend 3.91%; Price to Sales Ratio 0.50.
Synaptics, Inc.SYNA$40.36Forward P/E 7.85; PEG Ratio 0.70; Price to Sales 0.81; Price to Free Cash Flow 11.22.

*Please note that AB is a limited partnership and as such for most investors better suited for a tax-deferred account.

Nonetheless, and here is why the answer may be "it depends," there might be reasons not to sell and even to invest further now. Investors who try to time the market get it wrong more often than not. A possible explanation is that two decisions are required for successful market timing, both when to get in and out, yet on average they do not get even one right. The way it usually works is investors wait till the market is already up a lot before believing it is safe to buy stocks, but then they get scared after the market has been down for awhile and so sell at that point, thus completing an investing "round trip" cycle in the worst manner, buying high and selling low.

To counter this, a dollar-cost-average approach is suggested, putting roughly equal amounts of funds into the market at regular intervals, such as every month or year. This has the effect of assuring they buy more shares when the market is down, fewer when it is up, resulting in a lower average cost basis. In such a scenario, to be consistent one would keep buying at intervals (even now, for instance) regardless of what the Buffett value ratio indicates about current equity valuation.

There is also the choice to acquire shares of only high value to price stocks. This can be done no matter how overbought stocks in general become. In my view, during a high-priced market like today's there are few good low price to book value candidates to be found. Nonetheless, there are still some securities with reasonable or even bargain prices in relation to other measures of value, such as free cash flow, price to sales, price to earnings, dividend yield for the price, and price to long-term growth potential. At least a handful of excellent candidates might be found among stocks sharing one or more of these measures.

Benjamin Graham pointed out in The Intelligent Investor that we can almost never tell for sure when the market will crash vs. continuing to go up into more and more nosebleed levels of height in relation to underlying value. In the 1990s, even for a few years after Federal Reserve Chairman Alan Greenspan pointed out that the market was exhibiting "irrational exuberance," share prices were surging. An investor who got out of the market in, say, 1995, because the market appeared to him or her to be fairly valued or overvalued, might have had to wait till 2000 or later to see genuinely undervalued levels again. So Graham suggested we would do well to always be invested to a degree in stocks, though we might reduce them to as little as 25% of overall liquid assets.

Whether or not we like a Graham allocation model, it may be useful, even in overvalued market times, to acquire shares of stocks available at fire sale prices.

At the table above are a few that look enticing now. If the market falls a lot from here, to me they would also be fine assets in which to invest more later on. Having a set of such value stocks can be a first step in an investor's research. How he or she winnows the field down to just the few most desirable ones is an individual thing and part of the fun. Meanwhile, considering the currently lofty level of the Buffett value ratio, it might be wise to keep a large amount of one's funds in reserve.


Larry is not a professional. Don't take him seriously!

Actually, the investment article provided here is for general information only and should not be considered as professional advice, a solicitation to buy or sell any security, or the Word of God. Investors are encouraged to do their own research while considering their personal goals and circumstances, or consult their own professional financial advisors, before making investment decisions. Neither Larry nor LARVALBUG will be liable for any losses sustained by any visitor to this site.

(Disclosure statement: Larry and Val have holdings in some of the suggested assets but do not "make a market" in any of them and do not derive any direct benefit from recommending them, except perhaps for a bit of smug self-satisfaction.)

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