LOS ANGELES, Ca. (Feb. 27, 1998) -- A late bout of profit-taking trimmed the S&P 500's daily gain to less than one point Friday, while the Nasdaq ended a strong week by closing down 7 points.
The Boring Portfolio's intraday gains also evaporated, with four of six holdings losing ground. Included among the losers was Cisco Systems (Nasdaq: CSCO), which had set a new high of $68 1/2 during the day but closed at $65 7/8, off $5/8. Deutsche Morgan Grenfell, with its restarted coverage of network companies Friday, offered a "buy" rating on Cisco. That followed a similar rating by CIBC Oppenheimer on Thursday.
Perhaps of more substantive importance was Cisco's debut of its carrier-class access server, the AS5800, earlier in the week. This device promises to advance significantly the Kid's line of product offerings to communications service providers, including the very largest telecommunication companies.
This week's Borefolio recaps were devoted largely to setting out the Boring team's perspective on matters of valuation during this time of breathtaking performances by most of the major U.S. equities benchmarks. We detailed briefly our growing "wish list" of potential Borefolio investments, as well as our assessment that nearly all of them are currently fully-valued, and perhaps a good number of them are noticeably over-valued.
As always, our intention in setting down our line of thinking in public was not at all to posture as authoritative gooroos but rather to make clear to curious readers -- and to ourselves, as well -- what we were thinking, and why.
We've received a wonderful number of thought-provoking emails and posts in the "Boring Stocks" folder in reply. Thanks much, folks. And please do keep it coming -- especially in the folder, where all can join in the conversation.
Not a few participants pointed out that we voiced our concerns about valuation directly on the heels of a feature article in Barron's in which Goldman Sachs's highly respected market strategist, Abby Joseph Cohen, pronounced that anxiety about the current market's valuation is far overdone and that there are few if any signs on the horizon of factors that could hobble this strong-running bull market.
Do we think Cohen is missing something? Do we think we know more than she does about such matters?
Speaking for myself, the answers are "no" and "not even a little bit." Indeed, it is precisely because I agree with everything that Cohen articulated in the Barron's interview that we are believe that market valuations are probably at or awfully close to their peak.
First, as noted earlier this week, I agree entirely that, on the whole, U.S. stocks are not noticeably over-valued. I associate myself entirely with Cohen when she argues about the irrelevance of such criteria as the S&P 500's dividend yield (now at historically low levels, and for perfectly sensible and unexciting reasons), price-to-book valuations (the book value of the fast growing services and technology sectors is far less relevant than it is for capital-intensive industrial stocks), Tobin's Q (ditto), and the like.
Moreover, I agree entirely with her observation that folks who merely look at the p/e multiple of the S&P 500 and pronounce it 30 or 40 percent too high relative to its historic average value are apparently failing to consider the benign inflation and interest rate environment that the U.S. economy is enjoying -- and is reasonably likely to continue to enjoy for a good while yet.
Company earnings and prevailing interest rates are the two factors that drive stock prices, and in her interview Cohen pointed out that in previous eras that more or less matched current conditions -- such as in the early 1960s -- the S&P 500 traded at a multiple as high as 21 or 22 times the aggregate earnings of its 500 constituent companies.
Again, d'accord -- and therein lies the rub. Not a rasping, grating abrasion, mind you. Not a major case of road rash equivalent to that incurred after hitting a patch of gravel going downhill at 50 miles per hour. But a rub.
According to First Call, analysts project that operating earnings for the S&P 500 will reach $48.47 for calendar year 1998 -- or about a 7% increase over 1997. Those numbers are basically in line with Cohen's projections.
Pop a 21 multiple on those earnings and you're at 1018 as a target for the S&P 500 -- or about 3% below today's close. Use the tippy-top multiple of 22 and you've got 1066, or about a 1.7% gain for the S&P 500 over the balance of the year.
By the way, Cohen offered 1075 as her target. So you can see that we're pretty much in the same ballpark -- even standing at about the same spot in deep center field.
So, no, the numbers do not suggest particular overvalued conditions. But they do suggest that it's getting tough to find stocks that are likely to outperform the yield on a short-term note over the next year or so. That's what our own scouting about for such stocks is suggesting, too.
But we'll keep scouting.
Stock Change Bid ANDW - 5/16 27.63 CGO - 3/8 29.75 BGP +1 7/16 33.31 CSL --- 48.44 CSCO - 9/16 65.88 FCH - 9/16 35.88
Day Month Year History BORING +0.41% 4.09% 0.52% 26.48% S&P: +0.07% 7.04% 8.13% 68.81% NASDAQ: -0.37% 9.33% 12.74% 70.08% Rec'd # Security In At Now Change 2/28/96 400 Borders Gr 11.26 33.31 195.95% 8/13/96 200 Carlisle C 26.32 48.44 84.00% 6/26/96 150 Cisco Syst 35.93 65.88 83.33% 3/5/97 150 Atlas Air 23.06 29.75 29.02% 1/21/98 200 Andrew Cor 26.09 27.63 5.88% 11/6/97 200 FelCor Sui 37.59 35.88 -4.56% Rec'd # Security In At Value Change 2/28/96 400 Borders Gr 4502.49 13325.00 $8822.51 6/26/96 150 Cisco Syst 5389.99 9881.25 $4491.26 8/13/96 200 Carlisle C 5264.99 9687.50 $4422.51 3/5/97 150 Atlas Air 3458.74 4462.50 $1003.76 1/21/98 200 Andrew Cor 5218.00 5525.00 $307.00 11/6/97 200 FelCor Sui 7518.00 7175.00 -$343.00 CASH $13182.97 TOTAL $63239.22