====== Searching for value ====== 

[[http://www.economist.com/finance/displaystory.cfm?story_id=13382175]]  

Here's another terrific Buttonwood column from //The Economist// of March 26 2009. The topic is valuation. Shares are not dirt cheap. They discuss dividend yield and price/earnings and some interesting ideas on relative valuation including equity risk-premium.

Here's a fact I found fascinating. American investors have an estimated $13 trillion - yep, that's trillion - sitting in money-market mutual funds. The bulls say this is hopeful. I think people are scared. Eventually, in my view, people will not buy stock.

VALUATION: //The Economist's// Buttonwood column of March 26 2009 ( linked inside dividendgrowth.ca) discussed valuation. If you are still waiting to buy, note that market dividend yields have been higher than they are now (8.7% in 1950). Price/earnings ratios, computed various ways, have been lower too (of the S&P 500 "ratio of around six in 1949"). These valuation measures, however, are not necessarily a good guide at market extremes. When earnings fall, p/e ratios can rise: when dividends are reduced, yields vary too. Andrew Smithers reckons, //The Economist// said,  "that Wall Street is only around ‘fair value'." 

**ADD YIELD and DIVIDEND GROWTH**. On the other hand, if you want to buy a stock, you might consider this argument. I was most excited to see my favourite computation in //The Economist//. "A rough calculation for the forward-looking risk premium would be add the dividend yield of 3% to expected long-term nominal dividend growth (in line with GDP) of 5% and then subtract the ten-year bond yield of 2.7%. The result is a risk premium of 5.3%." The Economist defines equity risk-premium as "the extra return investors should demand for holding shares". "Since 1900", according to Dimson, Marsh and Staunton at the London Business School, "the equity risk-premium has been around 4% a year". Others, including Rob Arnott (I think...have to check) hold that the equity-risk premium is closer to 2.5%. 

If you are thinking a buying a financial stock, add its yield, say 6.5%, to expected long-term dividend growth of 5% and arrive at close to 12%. (more if it's Canadian dividends). Is it worth the risk to buy stocks at 12%? Compare this to a money market fund with a yield of next to nothing and fees. If the dividend holds, and if dividends start growing again before too long, you'll have a comfortable retirement income and a market beating return when you opt for companies where profit output is reliable...never mind what happens to the price.

Button_Mar09f destined for April Connolly Report