The Dow and the S&P 500 made new highs again today, continuing the theme of the last month. After another record day I think it’s prudent to look at where valuations stand. The Dow currently trades for over 19 times forward earnings, assuming a consensus 12% growth rate from present levels. This translates to a forward earnings yield of just 5.18%. This happens to be lower than the Fed Funds rate and about on par with the yield on money market accounts. Given the option between a fully priced market and a virtually risk free money market account yielding the same amount for the year ahead, the choice seems clear. From a Fed model standpoint, stocks are fairly valued.
By the way, the S&P 500 looks a little more reasonably priced at around 17 times projected earnings, translating to an earnings yield of around 6%. It seems the Dow fetches a richer valuation than the S&P on this basis but neither metric looks cheap.
If you have the ability to hold cash, it seems prudent to wait to invest new monies at this point. The market may rise further in the short-term, but it looks like the risk-reward balance is out of equilibrium at this point. Volatility has been low and enthusiasm high; a reversal in either could lead to a better entry point.
We discuss a broad range of issues that are often investment-related, but not always so. We call it a 'thought blog'. Sagacious: Having or showing keen discernment, sound judgment, and farsightedness.
Dow Approaching Overvaluation?
Home Depot Rallies on Bad News
Home Depot (HD) shares were down this morning on the heels of an earnings release but ended up sharply higher by market close. Revenues, same store sales results, and earnings all came in below expectations. Yet the share price rose by over 4% today. What gives?
Low expectations have depressed the shares, but Home Depot’s financial position remains very strong. The company carries prudent levels of debt and generates very high investment returns. Management reported 22% returns on invested capital for the quarter (after considering operating leases the real number is in the high teens). These are admirable returns to post in this environment. Despite a slowing business climate, the company has been using its free cash flow to buy back shares. CEO Bob Nardelli knows a bargain when he sees one. Investors must have noticed.
EPS is still expected to grow by 4% and sales should be up around 12% for the full fiscal year. Frankly, I would expect worse. But the valuation is far from demanding: the shares sell at just around 12 times forward earnings and operating cash flow. For a premiere franchise like Home Depot, there seems to be a margin of safety built in to the current valuation, though not as much after the recent run-up.
One problem I had with their reported results today: no cash flow statement. It’d be nice to see a cash flow statement in the press release. This would help us gain a clearer picture of what went on during the quarter and first nine months of the year. Maybe next time, Bobby.
Disclosure: I own shares for clients as well as personally.
Low expectations have depressed the shares, but Home Depot’s financial position remains very strong. The company carries prudent levels of debt and generates very high investment returns. Management reported 22% returns on invested capital for the quarter (after considering operating leases the real number is in the high teens). These are admirable returns to post in this environment. Despite a slowing business climate, the company has been using its free cash flow to buy back shares. CEO Bob Nardelli knows a bargain when he sees one. Investors must have noticed.
EPS is still expected to grow by 4% and sales should be up around 12% for the full fiscal year. Frankly, I would expect worse. But the valuation is far from demanding: the shares sell at just around 12 times forward earnings and operating cash flow. For a premiere franchise like Home Depot, there seems to be a margin of safety built in to the current valuation, though not as much after the recent run-up.
One problem I had with their reported results today: no cash flow statement. It’d be nice to see a cash flow statement in the press release. This would help us gain a clearer picture of what went on during the quarter and first nine months of the year. Maybe next time, Bobby.
Disclosure: I own shares for clients as well as personally.
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