Update No. 105 – 22/03/13

For anyone suspecting the recent market rally is unsupported by fundamentals (earnings) I propose you consider this wonderful graphic representation I found about a fortnight ago:

One should always be leery of charts, like statistics, they can sometimes be used to tell any story the author wants.  This chart I thinks serves to remind us how important the fundamental (profit earning capacity) relationship is when determining the underlying value of stocks and particularly the market as a whole.  I wish I could locate the same quality of informational data about the Australian market, but usually a great deal more effort is required to get the same information as is available on the US market (as above).

The S&P500 has recently matched/passed highs last seen in late 2000 (the ‘internet/tech bubble’) and again in late 2007 (pre-GFC).  The underlying earnings, however of the S&P500 are almost two and a half times greater than at the 2000 high and 25 or 30% higher than at the 2007 high.

This reminds us of Benjamin Grahams immortal advice that “in the short term, the stock market behaves like a voting machine, but in the long term it acts like a weighing machine”  (i.e. its true value will in the long run be reflected in its stock price).  He also explained that the price/value relationship can sometimes diverge for quite an extended period; the ‘tech-bubble’ seems to have led to at least a 5-year divergence between earnings and price in the graph above.  Eventually price will match the story the fundamentals tell.

I do not, it should be noted spend a particular amount of time fretting about market-wide earnings when making purchases.  At the individual level, I am simply looking to buy more than what I feel I’m paying for in future earnings.

In any case, I don’t think the Australian market has recovered (profit-wise) to quite the same extent as the US market, but the market trades at or near its historic multiples and forward guidance has mostly been a lot more positive than the last couple of years.  At the current market levels, I don’t believe you need to consider valuations a threat, serious threats to price levels are more likely to be driven by sentiment.  If you do your analysis and find a company whose prospects you like are fairly priced, then that should (as almost always) be your primary consideration – Tony Hansen 22/03/13

P.S. As mentioned in last week’s post, we once again held up well (EGP down 0.33%) in a strongly declining week for the market (benchmark down 2.88%).  A number of our stocks went ex-dividend this week and their prices didn’t reflect the full decline.

EGP Fund No. 1 Pty Ltd. Up by 14.00%, leading the benchmark by 5.83% since January 1^st. Since inception, EGP Fund No. 1 Pty Ltd is Up by 38.77%, leading the benchmark by 26.04% all-time (April 1^st 2011).