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How to save time valuing stocks.


THE signal-to-noise ratio in financial commentary is low. Two weeks back we suggested ways of raising it.

ANDREW One rule of thumb is that some valuation metrics for stocks, namely "Tobin's q" and long-term cyclically-adjusted price earnings (or CAPE) ratios, are of limited value and can be largely ignored. Here we explain our scepticism. Apologies for being a bit geekier than usual - and for temporarily adding to that noise. MILLER Tobin's q (for quotient) compares the market value of companies with estimates of the cost of (re)building them. It seems intuitive - why pay more than replacement cost to buy a business? Alas, the real world is not quite that simple. Data on aggregate replacement costs are patchy and unconvincing. More importantly, replicating a business as a going concern is not just a matter of re-assembling its assets. Microsoft, Apple or GSK's value does not reside in their premises, plant and equipment; Tesco's worth is not in its shelves; financial sector assets themselves are particularly hard to value. An inaccessible and flawed valuation tool is of little use.

The idea of smoothing corporate earnings in CAPE ratios to eliminate short-term noise is a good one, and pre-dates 'q'. But CAPE proponents often use US data stretching back to the late nineteenth century to argue that today's stock market is expensive relative to (say) its100-year moving average. Those claims are not supported. Prior to the Great Depression there weren't any well-established accounting standards, and earnings data from that period wouldn't pass muster today. Stock market indices themselves have changed drastically - from around a dozen or so railroad companies in the 1880s to today's multi-sectoral baskets with hundreds of names.

You may read that these ratios are historically proven, but they aren't: they were popularised long after the events they supposedly predicted. There is no short-cut to valuing stocks: it is an unavoidably subjective and constantly-evolving quest, and in our view the simpler and more transparent the statistical input, the better. To us, conventional PEs and the earnings outlook, dividend yields, price/book values and implied risk premia all suggest that stocks are not especially expensive. For sure, developed markets have gone some 15 months without even a 10% correction, and a setback in the weeks ahead would not be surprising - even though tapering seems largely priced-in, and an intervention in Syria seems less imminent. But such a setback in our view will likely reflect not valuations but events.

ANDREW MILLER is a director of |Barclays Wealth and Investment Management in Newcastle
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Title Annotation:Business
Publication:The Journal (Newcastle, England)
Date:Sep 18, 2013
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