What We're Reading

Ask 10 different money managers what metric they use to determine if a stock (or particular market) is overvalued, and you'll more than likely receive 10 different responses.  Of course buying at "the bottom" is easier said than done, as we all know so I submit to you this perspective.

Kyle Caldwell, personal finance reporter at the Daily Telegraph, determined whether stock markets were undervalued or overvalued. Caldwell used three measures: price to earnings (P/E), cyclically adjusted price to earnings ratio (CAPE) and price to book (P/B). His analysis included 34 countries, both developed and emerging and compared current measures to historical averages.

The CAPE adjusts for cyclical variations and takes a longer term view than the P/E considering the earnings average over the last 10 years instead of the 12 month average. Its premise is that eventually earnings will move back to their long term trend. Price to book divides the current value per share over the equity value sho

“After 5 years of a bull market, the only place left to invest is in value names”
“The best protection in this volatile market are value stocks”

How reliable are these sorts of claims?  Those promoting the approach offer lists of stocks that are considered undervalued typically when they meet such financial criteria as low price/sales, low price/book value, or high, stable and growing dividends. However, they rarely attach timeframes or price targets.

So I decided to do some “back testing”.  By searching the term “value stock lists”, I gathered a small random sample of such lists published in 2012-13; stocks in these lists met one or more of criteria that qualifies them as “value stocks” at the time.  I then compared their stock price on the publication date with that of twelve months later; as a benchmark, those changes were compared with against the S&P 500 change over the same period.  These were selected at random and space limitations prevented including more, I suspect others wou