puplava's wrap-up ... a 'should' read

  1. dub
    33,892 Posts.
    lightbulb Created with Sketch. 350

    There are 2 graphs which won't appear here. They can be seen by visiting Financial Sense Online's website at



    Today's Market WrapUp
    by Jim Puplava

    They Still Aren't Cheap

    The good news is that companies are beating estimates. The bad news is that business is terrible. Ford Motor beat estimates as losses narrowed to $130 million during the fourth quarter. The company is trying hard to cut costs; while the cost of its debt is rising. The spread on Ford debt over Treasuries, even though it has narrowed, is still 3.77%. Ford will also have to make greater contributions to its pension plan this year. Harley Davidson saw its shares fall as much as 13% today after the company left its production targets unchanged for the year. Sales growth at the company may be slowing. In the financial sector, Citigroup beat estimates, but reported that profits fell 37% due to loan losses and settlement charges. Citigroup added $254 million for loan losses taking its reserve base up to $11.7 billion.

    Like so many of last week’s earnings reports from Intel, Home Depot and GE to Microsoft, companies are beating estimates, even though business conditions are soft, getting worse, or remain sluggish. Judging by all of the spin, you would think that things were improving because losses aren’t as bad or company profits are coming in higher than analysts’ estimates. That is hard to do these days with estimates constantly being lowered and rejiggered prior to actual earnings announcements. For the average investor, it is hard to tell how things are actually doing. Companies are beating estimates, which is the way the earnings game is set up to be played. However, actual results leave much to be desired. Earnings have fallen precipitously since 1997. The descent in earnings has improved, but we are far from the go-go years of the 90’s. The years of double-digit earnings growth are over. As we found out last year, they were mostly fiction anyway. This year the earnings hurdle is going to come from pension contributions. After the losses in the stock market over the last three years, companies will be forced to contribute to pension plans this year. Unfunded pension liabilities for S&P 500 companies are estimated to run around $300 billion. That number could increase if the stock market has another losing year. When companies report earnings later on this year, will pension contributions be counted or will they be excluded like so many other expenses that make up pro forma earnings?

    Originally, pro forma numbers were only used when a company acquired another company. The purpose of the pro forma numbers was to give investors an idea what the new company’s earnings would look like. Since the declining earnings deluge began in 2000, all kinds of ordinary expenses have been excluded from most earnings reports. This is one reason, in my opinion, that the major blue chip indexes such as the Dow and the S&P 500 haven’t lost as much ground as the NASDAQ. Analysts and anchors still use bogus pro forma numbers instead of the real numbers, which would be much worse. This last summer when Standard & Poor’s revised what was counted as earnings for the S&P 500 companies, actual earnings were reduced from around $26 to $18. This drove the P/E multiple on the S&P 500 to almost 50. Buying stocks at 50 times earnings isn’t a bargain. If Wall Street and anchors started using the real profit numbers instead of the current pro forma fiction, the major averages would be selling at much lower levels.

    Stocks are more overvalued today than they were at the peak of the market in 1929. From a valuation perspective, the average P/E multiple has run between 12-14 throughout the last century. In bear markets P/E multiples have gotten as low as 7. Today the P/E multiple used by S&P, which is still not the bottom line but includes many more excluded expenses, is at 28. This equates to an earnings yield of 3.5%. For the Dow the P/E multiple is about the same at 28. These numbers don’t include the real bottom line but they are getting closer. This still doesn’t make stocks cheap.

    However, stocks today are sold times forward earnings. That is where an even bigger fiction comes into play. Forget the 28-30 P/E multiples. Investors are told to look at forward P/E’s, which aren’t as high because of those miracle earnings. Well, guess what? There isn’t going to be any miracle earnings this year. You can forget about S&P earnings of $48-54. These are bogus numbers used to justify current high stock valuations. The simple truth of the matter is that stocks are overpriced. The reason is that earnings have fallen faster than stock prices. In my opinion, prices haven’t fallen as fast as earnings because of this charade of pro forma accounting and reporting. If investors were told what the real numbers were, stock prices would be much lower.

    Dividends Rightly Divide The Truth
    Real numbers is one reason that the President’s dividend plan makes a lot of sense. Dividends don’t lie. You have to have real earnings and real cash to pay a dividend. There is no such thing as pro forma dividends. Either they are paid in cash or they aren’t paid. In the last decade dividends became passé. Companies elected to buy back stock or make reckless acquisitions with company profits. As a result of this carelessness of shareholder money, many companies diluted their stock and are now paying a terrible price in writing off worthless goodwill that resulted in overpaying for many of those acquisitions. In addition to worthless goodwill, many companies have leveraged up their balance sheet in an effort to buy back expensive stock and drive up earnings. Corporate indebtedness grew by over 50% from 1995 to 2001. Debt ballooned from $3.1 trillion to $4.8 trillion. Most of this debt was used to buy back stock or make acquisitions. The result is that companies effectively devastated their balance sheet and credit ratings. This is one reason for rising credit spreads between corporate debt and Treasuries. The result has been that collectively, corporate net worth has declined.

    From an investor’s point of view, this lower book value (the result of declining net worth) means that stocks are still relatively expensive. Book value has fallen faster than stock prices. The S&P 500 trades at 4.15 times book value. The S&P Industrial Index sells at 5 times book value. The Dow is no great bargain either trading at 3.49 times book value. Therefore, stocks are still selling at expensive prices.

    Then there are dividends. The one good thing about dividends is that you have to have real earnings and cash to pay them. There is no such thing as pro forma dividends. You either declare a dividend or pay it or you don’t declare a dividend. It is that simple. The company accountant can’t create the cash to pay a dividend. The cash to pay that dividend comes either from earnings or cash flow. If you don’t have the earnings or cash then you can’t pay a dividend. If you pay a dividend and don’t have the earnings, you either cut the dividend or you don’t increase it over time. During much of the 90’s dividends went out of style as companies emphasized mergers, acquisitions, or stock buybacks. Shareholders were told there was a better use for that cash with the company’s acquisition or stock buyback program. Those acquisitions are now in the process of being written off, which is one reason why book value has been declining so rapidly. The centerpiece of the President’s stimulus program is ending double taxation of dividends. This will once again put the spotlight on a very important aspect of stock investing which has been the return of profits in the form of dividends to shareholders. The spotlight on dividends will put pressure on companies to pay them if they are sitting on large amounts of cash. On the other hand, if company earnings are fiction, then they won’t be paid. Dividends keep a company’s earnings honest.

    Speaking of dividends, investors won’t find much when they look at the major averages. The S&P 500 yields only 1.77% and the S&P Industrials average only 1.55%. The dividend yield on the Dow is only 2.19%. Wall Street may shrug at these low yields and emphasize pro forma earnings, but investors ignore these low yields at their own peril. Over the last century, dividends accounted for 60% of the return on stock investments. With earnings growing at an anemic pace and dividend yields at this level, returns from US equities are going to be much, much lower.

    The point to understand here is that no matter which way you look at stocks in the US, they still aren’t cheap. Only looking at the markets through the rose-colored glasses of pro forma accounting do stocks ever appear as a bargain. That is because Wall Street is always selling stocks based on their forward earnings. With the latest trailing earnings for the S&P 500 at around $30 there is no way that you are going to see earnings for the S&P 500 this year at $48-$54. The only way you get there is to exclude most costs of doing business. Last year we had accounting scandals; this year we get underfunded pension plans as the profit killer. With the Dow, S&P 500, and the NASDAQ, which has no earnings, selling at these high levels we still have a long way to go before stocks can be considered a bargain again.

    Today's Market
    In the meantime, there are better opportunities in “things.” While stocks were getting hammered; the price of “things” was going up. The CRB Index rose as the price of precious metals, grains, and energy rose along with industrial metals. Crude oil rose to $33.19 a barrel; while copper, platinum and wheat rose close to 1%.

    Stocks fell for the fourth straight day in response to poor earnings from Citigroup, Ford, and Charles Schwab. Earnings expectations have been far too optimistic. Worries over the coming war with Iraq also shook investor confidence. The US has doubled its carrier battle group presence in the Persian Gulf. Wall Street seems to be placing the market’s woes on Iraq instead of where they should be, which is the real bottom line.

    The markets ignored the good news coming from the housing bubble, which appears to still be in full bloom. Housing starts jumped 5% last month. Instead of a rally on the housing numbers, the markets fell on worries over earnings and capital spending plans by business.

    The major averages have now given back most of their gains for the year. Volume was anemic at 1.3 billion shares on the NYSE and 1.36 billion on the NASDAQ. Market breadth was negative by 22-10 on the Big Board and 20-12 on the Nasdaq. Trim Tabs reported today that mutual fund inflows were $800 million last week with $3.2 billion flowing into stock funds over the last two weeks. The VIX rose 1.85 to 30.53 and the VXN advanced .40 to 43.24.

    Overseas Markets
    European stocks fell for a fifth day as Aviva Plc, the largest British insurer, said it sees sales stagnating this year and amid concern about the prospects for war with Iraq. The Dow Jones Stoxx 50 Index shed 1 percent to 2315.19, taking its five-day drop to 7.1 percent. The Stoxx 600 Index fell 1 percent, with banks and oil companies such as Shell Transport & Trading Co. accounting for almost half the loss.

    Japanese stocks rose, led by Nippon Telegraph & Telephone Corp., after the Nihon Keizai newspaper said the government will allow the nation's biggest phone company to charge competitors more to use its network. The Nikkei 225 Stock Average climbed 1.8 percent to 8708.58.

    Copyright © 2003 Jim Puplava
    January 21, 2003


arrow-down-2 Created with Sketch. arrow-down-2 Created with Sketch.