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Market in Pictures – Issue #4

Market in Pictures – December 2020

Looking for Value

We venture that few investors would have foreseen stocks at these levels had they known 2020’s timeline of events in advance. We have little if any idea on irrational exuberance or market tops but have some thoughts on where to, and where not to, look for value.

Option activity, measured in terms of call options, a bet on higher prices, is currently setting records:

Measured with virtually any known fundamental metric, P/E ratios, cash flow, the Q ratio, market cap to GDP, and many others, the market appears richly valued. Nobel Laureate Robert Shiller, a rather sane and sober observer of long-term trends, does note that his long-term CAPE ratio, a measure of long-term P/E ratio, less 10-year yields, suggests some value remains in purchasing equities at current levels.

Outside of the US, opportunities for earning any yield at all, even with credit risk involved, look increasingly grim; headlines today note 10-year bonds in Portugal now yield 0.00%. So, even a zero percent target return now entails credit risk. In China, a recent auction for 5-year bonds at negative rates was oversubscribed.

In the US, equity market investors appear to embrace risk in places we would not be comfortable. Among stocks most exposed and damaged this year, several leisure, gaming, and food stocks have stock prices well higher on the year, some with enterprise values even yet higher.

We suggest investors not try and complicate their analysis in a year that has challenged, if not destroyed many investing strategies. Opportunities exist in a multitude of companies with sustainable and repeating revenues, with cash flows and often dividends in excess of bond yields, and investors could do far worse with greater effort focusing elsewhere.

Rotation

The past month has seen a record month for small stock returns and a bounce in previously lagging sectors.

Some market observers assert we are witnessing a market rotation to small value stocks, which could have a substantial amount to run higher. While there is much debate about what is actually a value stock, we prefer our own framework. We believe a strategy for investing that consistently buys cheap cash flows will be rewarded.

Author

  • Applied Finance, a thought leader in valuation and portfolio construction, is a true “value” investment management company.  Unlike the majority of firms today that focus on low multiples to define “value”, we define value as identifying companies trading below their intrinsic value.  Our Valuation Driven™ approach forms the foundation of our investment decisions...more

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