QuoteOriginally posted by: BullBearQuoteOriginally posted by: sepparAlso a related article from Bloomberg:Dividends Falling Means S&P 500 Is Still Expensive In general, the "buy and hold" investment strategy is broken. With HF, Leveraged Short/Long ETF, High-frequency trading, the equity is just a vehicle intended to make short-term profits. If you want to benefit from a dividend stream, then better buy bonds - the risk-adjusted return is higher and entry-exit decisions are easier to take.Theoretically, dividend yields and dividend amounts should mean nothing to firms' valuations. The cash will get out of the firm so the mkt cap will be adjusted. In the current situation, when there's little risk taking then:- firms that are able to keep paying dividends: will attract more investors since it will signal that the firm is robust and can release funds to shareholders- firms that are needing more equity: slashing dividends increases equity but signals a tough environment for the firm. (typical case of Financials and highly-leveraged firms)Anyone saying that dividends falling, per se, means S&P500 is expensive dunno what's saying!Maybe, maybe not.Four reasons for assigning a higher valuation to dividend-paying stocks and, by extension, judging stocks on a price-to-dividend ratio basis:1) preferential taxation of qualified dividends2) psychological preferences for dividends (dividends = steady repayment of invested capital)3) amelioration of liquidity and valuation risks4) management's signal of confidence in steady earningsBy that logic, a falling dividend yield implies that stocks are "more expensive."Of course, the flip-side is that sticky dividends are quite dangerous. Some believe that the banks, in particular, have dramatically increased their risks of bankruptcy by maintaining generous dividend payouts as a show of confidence. Perhaps these firms have already distributed their book value of shareholders?

Why I don't like to argue on market index valuation metrics: The S&P Gets Its Earnings Wrong S&P doesn't take weights into account!?There's also a flaw when looking at historical market index metrics - the firms and index composition is always changing. Existent firms now are different from those on 1920... There's also a Darwinian evolution in the markets which preserve the stronger firms (Coca-Cola, Disney, McDonalds, Nike, Sony, Microsoft, Exxon Mobil, IBM) and get rid of weaker firms (lehman, bear, enron,...). Most robust and old firms are alive for decades... Their franchise value is unique so will be the franchise value of survivors.For example, a Bank able to survive and quickly expand its activity will boost its franchise value locally and overseas - "Solid as rock" type of marketing.

QuoteOriginally posted by: BullBearWhy I don't like to argue on market index valuation metrics: The S&P Gets Its Earnings Wrong S&P doesn't take weights into account!?The existing sum-of-dollar-earnings DOES take weighting into account. Jeremy Siegel's logic is so deeply flawed, that what he proposes would actually induce a weighting squared term in which money-making companies (whose share prices and market caps are, no doubt, higher) would effectively dominate his calculation of earnings. It's mathematical rose-coloured glasses.The proper way to look at this is to realize that each unit of the S&P 500 buys a fixed fraction of each of the underlying companies. Buy the right amount of S&P 500 index shares, and you'd own 100% of every company on the index. The weighting means you'd own 100% of the small companies (in a small $-fraction of the investment) as well as 100% of the big ones (in a large $-fraction of the investment), too. It also means that you'd accrue 100% of the dollar earnings and losses of each company. Thus the earning on the S&P are the sum of the dollar value of earning of the components and each share in S&P earns a piece of that.A second way to look at this is to imagine putting $100 into one share of a two-stock index in which one stock has 9X the market cap of the other. Imagine that both companies have a 1,000,000 shares and that the price of the big company is $90/share and the small company is $10 (i.e., market caps of $90 million and $10 million respectively). Then the big company reports earnings of $9 million and the little company reports losses of $9 million. Total earnings are zero. Your $100 investment just earned $9/sh from the big company, but lost $9/sh from the small one. The net gain to you to your share of the index is zero. Seigel's calculation would insist that you earned $7.2/share by double weighting the gains of the big company.QuoteOriginally posted by: BullBearThere's also a flaw when looking at historical market index metrics - the firms and index composition is always changing. Existent firms now are different from those on 1920... There's also a Darwinian evolution in the markets which preserve the stronger firms (Coca-Cola, Disney, McDonalds, Nike, Sony, Microsoft, Exxon Mobil, IBM) and get rid of weaker firms (lehman, bear, enron,...). Most robust and old firms are alive for decades... Their franchise value is unique so will be the franchise value of survivors.For example, a Bank able to survive and quickly expand its activity will boost its franchise value locally and overseas - "Solid as rock" type of marketing.The way to look at this is that the S&P 500 is really just a mutual fund with S&P being the fund manager in picking the investments. Yes, the fund does have turnover, but that does not mean that the fund/index doesn't have a consistent NAV that is defined over time (as long as the index turnover events are properly priced into the index).

I have to check Siegel arguments coz yours made sense. But I have a more interesting argument than Siegel's, I hope.For example almost bankrupt fims with a tiny weight.Suddenly, the firm posts a huge loss in the quarter. They have almost no weight in the index return but that huge loss would influence the sum of earnings of the S&P P/E.For example GM: they have been reporting huge losses (they have negative book value also) and their market cap is tiny. They've reported $9.6 B and their market cap is $1.5 B.First, there's limited liability and these earnings would skew the analysis.Lastly, GM represents (more or less) 0.03% of the S&P500 and so you have really low exposure to it. A huge write-down or operating loss (in accounting terms) skews the aggregate earnings of the S&P500 portfolio and your P&L exposure is low (disregarding correlations).So, in terms of rich/cheap analysis in this case I guess aggregating earnings can be misleading. Actually, we're turning back to a previous point where I said that trailing P/E is not a good metric for current market environment (due to bankruptcies, limited liability, write-downs, balance sheet cleansing, one time losses, credit squeeze last quarter, restructuring costs, ...).

I agree that the situation for near-bankrupt firms is more complex due to limited liability effects. By any first order analysis, GM's large loss is not directly deducted from investor's wallets or from the balance sheets of other S&P stocks. I can see the point that the most that S&P shareholders can lose is the market cap. In that sense, the effects of GM's loss is attenuated by GM's small market cap. But I still have three problems with Siegel's method.First, the bankruptcy effect does not imply that the $ profits of a large cap company should be further multiplied by the company's market cap. $1 earned by a large cap company does not have a greater economic effect than $1 earned by a small company. For thriving companies, each $1 of earnings (or losses) counts equally. (Would Siegel argue for attenuating GM's results if GM had delivered a surprise $9 billion profit?)Second, if the S&P 500 is meant to be a proxy for the overall economy, then a large loss by GM does deserve non-attenuated inclusion. GM may have a small weight in the S&P due to it's near-zero stock price, but it represents a rather larger segment of the economy than it's market cap would seem to indicate. In that regard, GM's large loss does flow on to the balance sheets of other S&P companies over time (via payments to suppliers, employees, debt holder, etc.) In general, large losses (or large earnings) do flow into the economy regardless of the current market cap of the company.Third, Siegel's method would make the the S&P figures much more volatile. In general, large market cap companies tend to be companies with large sales and large magnitude earnings (and losses). With Siegel's method, multiplying the large magnitude earnings (and losses) by the large market caps would yield especially extreme values on the S&P earning metrics.Perhaps the solution is a more nuanced analysis that takes into account bankruptcy (which is the real issue with a company such as GM). It's not the S&P weight that matters, but that proximity to bankruptcy matters.

QuoteOriginally posted by: Traden4AlphaPerhaps the solution is a more nuanced analysis that takes into account bankruptcy (which is the real issue with a company such as GM). It's not the S&P weight that matters, but that proximity to bankruptcy matters.Agree.Anyway, P/Es suck for current environment.One time items, inventory write-downs and balance sheet cleaning (last quarter) bias the P/E story. I rather take a look at specific firms (sector leaders and main competitors) and try to see past the turmoil - Keeping the "P" at the current level what would be the forward P/E in 2009-2012.I also like PBV after write-downs. If PBV is (far) below 1 then most times the firm's valuation has a huge discount rate (near-brankruptcy valuation style). There are lots of firms with low PBV - together with the reading of huge VIX levels - so I guess the market is pricing a huge discount rate (bankruptcy option style, depression style, pricing) despite any view on historical P/Es. But they can go bankrupt...

I think you should use market-cap to GDP: Barrons ArticleBuffett uses this measure (stock market cap < 80% of GDP as an entry). However the last times it took 20 years (1940-1960 and 1970-1990) for the measure to retreat from 40 back to over 80.A more approriate measure than PE might be a PE ratio average of 10 years, such as Shiller uses. However earnings have collapsed faster than the stock market. I don't know what the ratio of tangibles to intangibles now as compared to earlier. Perhaps assets net of intangibles and investments should be used instead of book values to estimate a floor.

QuoteOriginally posted by: macrotradeI think you should use market-cap to GDP: Barrons ArticleInteresting! That's as good a ratio as any (and better than most). Of course if the GDP falls another 10%, then the 40% floor for the S&P will be 488.Shiller's 10-year PE isn't bad, either except that it now spans the internet and housing bubbles. Perhaps we need a 100-year Shiller that spans a larger number of business cycles.In all of these ratios are the assumptions that the S&P 500 companies hold a relatively constant fraction of the economy, that they have a relatively constant long-term level of earnings, and that investor's demand for "risky" equity-provided earnings holds constant. The first assumption seems fine to me (entrepreneurs notwithstanding), but the second two seem wrong to me. Growing taxes and on-going debt payments will be a real drag on equity earnings as a % of GDP. The continuing aging of the Baby Boomers will also dampen appetites for risky returns.One reason that the market has lagged the drop in earnings is that everyone still has rosy forecasts for 2010. For the past 18 months, everyone has assumed that recovery was only 6 months away with a nice V-shaped recovery.