"I don't need a friend who changes when I change and who nods
when I nod; my shadow does that much better".
Plutarch's muse hints at the root of advice executive
coaches provide that, "challenging your boss or a friend is often
wanted and encouraged", that is if they are indeed to be admired
and worthy of such discussions.
This 2000 year old quote by Plutarch also warns of the dangers
of groupthink and the herding mentality that often exists (such as
on Wall Street and elsewhere in the mainstream). To really be
a friend, tell me when I am wrong or misinformed, don't just stand
idly by and contribute to my failure.
GroupThinking
Wall Street Strategists are in the process of releasing their
2013 market expectations which inevitably include a 2013 market
(NYSEARCA:SPY) projected growth rate. What do you think it
will be?
Here's a hint: In 2010 they suggested the market would rise
around 10% and in 2011 the consensus was a rise of about
10%. In 2012 the median strategist assumed a growth rate of
10%. What do you think they are expecting for 2013?
10% it is! This of course has more to do with sticking to
the historical average than it does sticking a neck out to make a
call.
It is also no coincidence that Wall Street Analyst consensus
"Hold" ratings on stocks such as Exxon Mobil (
XOM
) and McDonalds (
MCD
) are at an all time high of 67% (analyst "holds" were under 30% in
the year 2000). The amount of "sells" still hovers around
only 5%, since I guess pretty much all companies are still (as
always) great to own.
Groupthink at its finest.
The Multiple Problem
The bigger problem here is that the groupthink can only go on
for so long before logic, math, and evidence make the prevailing
argument ever more difficult. Wall Street has that problem
now with their constant arguments for continued stock multiple
expansion (or even the maintenance of it).
Recently, the controversial Jim Cramer endorsed Starbucks
(NasdaqGS:SBUX) and justified it partly because it is trading below
its historical multiple. "Starbucks sells for 23.8 times next
year's earnings estimates," Cramer said. "That's below the
company's five-year average historical multiple of 28.2 times
earnings, and it's also a major discount to other high-growth food
chains."
The problem with Cramer's flawed reasoning is that
multiples across all stocks have actually fallen even though they
have had one very huge tailwind. But unfortunately, the tailwind is
starting to blow softer and softer and will eventually reverse,
becoming a headwind on prices.
Back to School - Valuation Fundamentals
The spreadsheet below is a very simplistic, yet meaningful,
example of the financial model called the discounted cash flow
which is used in many shapes and forms all through the finance
world. It is used extensively in the valuation of stocks and
helps explain why valuations and multiples are much nearer their
highs than their lows te reason being discount rates are very near
their all time lows, and realistically can't go much
lower.
A discount rate of 6% yields a stock valued at $510 based on
this example. Do you know what simple (and inevitable) event
will cause the discount rate to increase and thus the prices and
multiples to fall? Here is a hint, it has been a positive
tailwind for stocks since 1981.
In our October ETF Profit Strategy Newsletter we identified 12
MegaThemes that help readers to cut through the noise and
successfully navigate the markets (NYSEARCA:IVV).
One of our mega themes is that stock valuations are closer to
their peak than their ultimate low. For that reason, we are
warning subscribers. "Discount rates (NYSEARCA:TLT) are at all time
lows. Discount rates will rise and multiples will
contract."
When discounts rise and multiples contract, guess what happens?
Share prices also contract.
In an upcoming issue of the
ETF Profit Strategy Newsletter
we will dive into stock valuations and the key factor that will
significantly change over the next few years driving multiples
down. Don't give into the groupthink and conflicted interests
of Wall Street,. It's better to use logic and evidence based
decision making to drive your long term investment decisions.
For more updates and ways to protect your portfolio follow
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