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Stocks B / Berkshire Hathaway


Subject:  Re: Berkshire's P/B Date:  1/25/2013  12:33 AM
Author:  mungofitch Number:  198112 of 235656

I recall Jeremy Siegel saying that the long term average PE for US stocks
is about 15 but in low interest rate environments, it's higher, at about 19.

It's certainly true that the average market multiples aren't the same in
high interest rate environments and low interest rate environments.
(the average multiples are also not the same in high barometric pressure
and low barometric pressure environments)

But prevailing interest rates don't change equity values.
They only change the mood of the market by changing the apparent current
relative attractiveness of equities and bonds.
Thus changes in current interest rates might predict the short term
direction of the market, but they don't change the fair value of the market.

Equities purchased at low multiples of trend earnings will give you
high real returns in the next 5,10,20 years whether interest rates or
real interest rates were high or low when you bought, and vice versa.
If an input doesn't change your returns, it isn't a factor for fair value.

Perhaps (just perhaps) a better way to slice it is to note that average
market multiples are higher when inflation is relatively normal versus
when it's doing something which tells you the economy is broken.
Say, inflation 0% to 6% might be normal but negative or super high are bad.
"Normal" times, trailing year inflation 0% to 6%:
Average observed multiple of trend earnings since 1871 = 15.1x, average since 1940 15.8x
("normal" inflation seen 56% of the time since 1871, 76% of the time since 1940)

"Abnormal" times, trailing year inflation negative or >6%:
Average observed multiple of trend earnings since 1871 = 11.5x, average since 1940 9.8x

Since inflation is by this definition entirely normal right now one
might speculate that seeing a multiple in the ~15.5x range might make sense.
My estimate of current on-trend earnings is in the rough neighbourhood
of $73 which would put expected S&P level at around 1130 on that view.
The downside of this happier viewpoint is that if/when inflation gets
outside the normal range you'd have to drop your expectations of
"normal" multiples by 30% overnight. Ouch.

I prefer to use a single long run average because you don't wake up
one morning with an entirely different definition of "normal" or "fair".
The average multiple of trend earnings since 1940 has been around 13.8x.
13.8 times $73 would be fair value around S&P 1007 (in Dec 2012 dollars)

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