Oct 22, 2015
By Paul J. Kronlokken, CAIA
Over the past year, there has been a presumption that equity valuations are high, which has been a cause of concern for many investors. At Palisade, we are also concerned that this broad perception has been supported with the recent market turmoil and the fanning of the flames by the media pundits. We must point out that for parts of the equity markets, this may be true, but completing some simple research shows us that markets, market sectors, and individual stock valuations are not all valued the same. In fact, we presently see quite a few positive investment opportunities.
Some answers can be gleaned from today's metrics when compared to the same data historically. The Price to Earnings ratio (P/E) is one of the most commonly used and simpler ways to determine whether stocks are under/overvalued. As different market valuations vary, we compared them to historical P/E valuations. Over the past 20 years, the S&P 500 Index's median P/E is 17.3; the low P/E stands at 10.7, while the high P/E is 30.4. Currently, the S&P 500 index has a P/E value of 16.1 (as of 09-30-15).
This indicates that there is actually room for the U.S. equity market’s continued growth. When looking at specific sectors (see chart below), 7 of 10 sectors: Staples, Financial, Healthcare, Industrial, Technology, Material and Telecom are trading below their 20 year median P/E. The three sectors of Consumer Discretionary, Energy and Utilities are trading above their 20 year median P/E.
Additionally, when analyzing the stocks that make up these sectors, we uncover that many high quality stocks are trading at even lower historical valuations than their broader sector and overall equity markets indicate. Here are just a few examples of high quality stocks that are trading below their respective 20 year historical median P/E ratio:
Despite the equity markets experiencing negative price volatility from all-time highs, lower than historical valuations can be found when analyzing the current P/E ratios of various sectors and individual stocks. Media prognostications aside, a well-balanced portfolio of high quality stocks with consistent growth of earnings and dividends should offer investors a relatively attractive equity return.
By Dennis M. Ott, CFA
Recently, one of my clients asked for my thoughts about an article written by another money manager. Like many of his peers, this manager was placing 'buy' and 'sell’ targets on the stocks he was discussing. Certain money managers follow this portfolio management process, but at Palisade our philosophy does not focus on this target price trading discipline. Instead, we strive to buy high quality growth companies for our clients at fair valuations, to build portfolios that participate in the long-term growth of earnings and dividends.
At Palisade, we have always been long-term investors. We believe that if a stock is truly a good investment, a purchase price of plus or minus 5% means less over the long-term. As a company's earnings and the market’s perception of these companies evolve, valuations are always changing. Sell price targets may easily become meaningless when market and individual stock valuations change. Lastly, the short-term orientation of a sell price target may cause investors to eliminate a stock too early in its growth cycle; often missing large future price appreciation.
This discussion does not suggest that we never sell holdings in our clients' portfolios, nor invest without regard to disciplined research and valuations. Our investment management process has us constantly evaluating our portfolios and reviewing candidates for addition or deletion.
Additionally, tax consequences are an important consideration when managing our investment styles in client’s taxable portfolios. This is especially true in high tax states such as Minnesota, where an investment held less than one year can incur a combined Federal and State capital gains tax of nearly 50%. When we purchase a stock, we plan on a long-term holding period that helps to minimize on-going capital gains in taxable account portfolios.
Having buy and sell price targets may provide positive returns for the lucky trader, but in our opinion, doing so adds unnecessary volatility. Increased buying and selling activity increases the number of times a trader must be correct, which is not a simple undertaking with both volatile markets and unpredictable stock valuations. Having the patience to own good companies through these volatile periods is what allows investors to participate in long-term earnings and dividend growth that supports the long-term growth of their investment portfolios.