Former Federal Reserve Chairman Alan Greenspan wrote a long, wonky paper on the economy last week. Among his many musings:
Despite the surge in corporate cash flow over the last two years and expectations of security analysts of continued gains in profitability, equity premiums remain near a half-century high. This indicates an exceptionally large and presumably unsustainably high discount rate applied to expected future earnings. If the latter holds up, and activism recedes, stock values, of course, would move higher and carry with them a significant wealth effect that should enhance economic activity.
This roughly translates to: Stocks are cheap compared with the alternatives. Thus, a bull awaits.
Of course, it's not really that simple. The whole idea of accurately measuring equity premiums -- stocks' excess return over a risk-free interest rate -- is debatable, and some analysts whose reputations are slightly more esteemed than Greenspan's would disagree entirely that today's equity premium is actually high.
A quick-and-dirty metric -- which sort of smells like the equity premium I often use to judge the worth of some stocks (mainly blue chips) -- determines whether the dividend yield is greater than the yield of 10-year Treasury bonds.
This is imperfect: The payout ratio, earnings growth, and industry dynamics should all have to be considered as well. But it's still a decent starting point.
Several good companies, including Intel
What do you think of Greenspan's prediction? Holler away in the comment section below.
