It all seems like a blur now. The New Economy. Daily double-digit percentage gains. Overnight stock market millionaires.
ILLUSTRATION BY DAVID SWANN / DSWANN@STARBULLETIN.COMHow low can it go?
P/E ratios and other mysteriesBy Dave Segal
dsegal@starbulletin.comNo longer is it about how high the market can rise but rather how low will it go.
Call it the stock market limbo, if you will.
As the bar keeps getting lower, analysts and investors keep waiting for the eventual bottom that will signal the end of one of the worst market slides in history.
But several Hawaii stock market experts are warning investors that things still could get worse before they get better.
"The only thing I can say is what (legendary mutual fund manager) Sir John Templeton said on TV the other night: that at the time of the Great Depression, the whole valuation of the market went down 90 percent, and this time it's down only 50 percent, so we can go down another 40 percent," said Gordon Ching, president of the Aloha Hawaii Chapter of the National Association of Investors Corp., a nonprofit organization dedicated to investment education. "That would scare me, but luckily I have time. I look at my stocks and they still have cash and very low debt, so I think they can hang around for a few more years."
Of course, these are different times than the 1920s and 1930s when the Dow suffered its worst decline. Back then, investors weren't worried about jets crashing into buildings, suicide bombers and accounting scandals.
Despite today's prevailing doom and gloom, though, the blue-chip index at 9,474.21 is off just 19.2 percent from its all-time high of 11,722.98 on Jan. 14, 2000. At its bottom on Sept. 21, 2001, the Dow was down 29.7 percent from its pinnacle. The Dow's current doldrums pale in comparison to 1972-1973 when the index fell more than 40 percent and 1969-1972 when it dropped about 35 percent.
But it's a different story for the two other major indexes, especially the Nasdaq.
The pricking of the Nasdaq bubble is probably what has caused the most hand wringing. The technology-heavy index's drop from 5,048.62 on March 10, 2000, to 1,423.19 on Sept. 21, 2001, represented a staggering 71.8 percent collapse. The Standard & Poor's 500, meanwhile, fell 36.8 percent from its high of 1,527.46 on March 24, 2000, to 965.80 on Sept. 21, 2001.
Harlan B.K. Cadinha, vice president of Honolulu broker Cadinha & Co. LLC, cites economic uncertainty, corporate impropriety and world unrest for the current malaise but said he thinks the market is searching for a bottom.
"I think it's possible that the market could break through its Sept. 21 lows but I think it's more likely that it will retest it rather than break through it," he said.
At today's levels, that wouldn't leave the S&P 500 and the Nasdaq much farther to fall. The S&P 500's close at 1,007.27 Friday left it just 41.47 points, or 4.3 percent, above its Sept. 21 low. The Nasdaq, meanwhile, ended last week at 1,504.74, leaving it 81.55 points, or 5.7 percent, above its Sept. 21 bottom. As for the Dow, the index is still 1,238.40 points, or 15 percent, above its Sept. 21 low of 8,235.81.
Despite the temptation to call bottoms, Barry Hyman, portfolio manager and vice president in the Wailuku, Maui, office of Financial & Investment Management Group Ltd., said he won't fall into that trap.
"Picking bottoms or tops is a foolhardy game," he said. "You can make estimates based on logical, rational measures but the behavior of investors over any short time span, say less than three years, is frequently not logical. In the short term, greed then fear drive investors. ... In fact, when stocks fall as far has they have in the past two years, fear often takes over and people panic sell, the way they were panic buying during the mania. I don't know if the (post) Sept. 11 lows will hold, but if that support level is broken, then there is a good chance the major indexes could fall quite a bit more from there."
Most stock experts agree that the key to a market recovery depends on companies reporting improved earnings.
"The only thing that can lift the market now is good sustained earnings over a couple of quarters," Ching said. "Then, we'll see confidence coming back. Until then, it will be a down or sideways market."
Certainly, 11 interest rate cuts by the Federal Reserve and recently improving economic reports have failed to do the trick. But that's partly because the economic numbers were "artificially pumped up," Hyman said.
"Tax rebates and home refinancing are one-time shots in the arm for the economy, not sustainable long-term economic growth enablers," Hyman said. "Furthermore, there has been so much earnings engineering by public companies for so long now that while many are being forced to justify their accounting, their earnings are turning out to be less than they anticipated.
"Public corporations have spent the past decade managing their stock and earnings rather than managing their businesses. ... Now their stocks are under pressure because earnings are not up to expectations."
Cadinha said the key to the market turning around may hinge with what happens in the November elections. He said that if the Republicans win a majority in the Senate and seize full Congressional control, then President Bush will have little resistance in pushing through his agenda.
"If the Republicans win, I think the Dow could reach 12,000 to 14,000 by the end of the year," Cadinha said, acknowledging that a 14,000 Dow represents nearly a 48 percent jump from its current level. "I think since Bush got elected, the turning point in the market was when Sen. (James) Jeffords changed parties from Republican to Independent and the power in the Senate shifted to the Democrats. What's happening now is that Bush's agenda has to be negotiated and it's no longer a slam dunk. If the Democrats win, I think you'll see more of a status quo in the market."
Ching is far less optimistic and sees the Dow, as well as the S&P 500, posting small gains for the year with the Nasdaq ending higher but still under water. He forecasts the Dow will hit 11,000, the S&P 500 1,500 and the Nasdaq 1,700.
So far this year, the Dow is down 5.5 percent, the S&P 500 is off 12.3 percent and the Nasdaq has fallen 22.9 percent.
Hyman, who follows a strict value-investing style, said he's not concerned about where the indexes will end the year.
"We construct portfolios one security at a time and pay no attention to the indexes, so it really does not matter to us if the market goes up, down or sideways," he said "We have had very steady, consistent performance despite the wild swings of the major market indexes."
One projection that has caught Hyman's attention, however, is the consensus forecast of analysts that stocks in the S&P 500 will earn an average of $51 a share over the next 12 months, a 113 percent jump over the index's current earnings per share of $24.
"I question (on) what the supposedly unbiased analysts on Wall Street are basing this outlook," Hyman said. "They are saying that in the midst of this current economic environment, where companies are announcing revenue estimate reductions, being forced to restate earnings (lower), and are being forced to adopt less aggressive accounting principals than they have been using in the past are going to increase their earnings by more than 100 percent over last year? It just doesn't seem to be realistic to me."
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The party's over and it may be time for investors to sober up and seek help. How to unlock the mysteries
of book value and P/E ratiosWith a continually spiraling market,
now may be the time to seek out
professional assistanceBy Dave Segal
dsegal@starbulletin.com"The bull market of the '90s was great for investors because very little mistakes could be made and everything tended to go up," said Harlan B.K. Cadinha, vice president of Honolulu broker Cadinha & Co. LLC. "The market we're in now is hit or miss. It's like finding the needle in a haystack."
For investors going it alone, sorting out overvalued investments from those that are undervalued has become a paradox. Some stocks that analysts once considered attractive at much higher prices are now being called overvalued at prices one-tenth of their previous levels.
In one brokerage television commercial, a father sits behind a computer screen and shows off to his adolescent son how he does his own stock research. The father rattles off some information about the stock and then mentions that the stock has a "15 P/E."
The son asks, "Is that good?"
The father is speechless. The commercial shifts gears and the sponsoring brokerage suggests it may be time for investors to get assistance. Nowadays, more stock research is available online than ever before. Yet, it's still easy for investors to drown in a sea of numbers.
So what's an investor to do?
"Of utmost importance, investors should first make sure a company's fundamentals are sound," said Barry Hyman, portfolio manager and vice president in the Wailuku, Maui, office of Financial & Investment Management Group Ltd. "The challenge for investors is to invest only in companies with solid and clean balance sheets, with positive cash flows and low debt that are selling at prices below their intrinsic values.
"But it is also very helpful to know who the major owners of a stock are. Technical analysis, or the use of stock charts, is very helpful in trying to determine whether the control of a stock is in the hands of lots of small, individual investors, or whether the institutions have control of a stock."
Gordon Ching, president of the Aloha Hawaii Chapter of the National Association of Investors Corp., said two of his favorite methods for determining the valuation of a company are using either the five-year history of the company's price to earnings ratio or looking at a company's price to earnings growth ratio.
The P/E ratio, the premium for which a stock can be purchased, is determined by dividing a company's stock price by its earnings per share. The growth ratio, known as PEG, is the P/E ratio divided by a company's projected earnings growth rate.
"If the PEG is around .9, or 1.2 to 1.3 on a fast-growing company, then we say it's reasonably valued," Ching said. "We'd consider a fast-growing company anything around 15 to 20 percent projected earnings growth over the next five years.
"For myself, I still buy companies that have no debt or very little debt. I like them to have a strong balance sheet because you don't know how long this down market is going to last. It could be four years and we've already had two years of this."
Cadinha said one metric he likes is to compare a company's current P/E to the historical standards of the broad-based Standard & Poor's 500 index.
"The P/E for the S&P 500 historically over the last 15 years has been 15 to 20 compared to about 42 where it's at now (and estimated at 20 over the next 12 months)," Cadinha said. "So any company above 20 is probably on the pricey side. But that's all relative depending on the industry and the actual stock.
"Clearly, for the average investor, an indicator to look at would be what the top and bottom lines are for a company. The top side would be the revenues or sales and the bottom would be the earnings growth. If a company has a high revenue stream and high earnings stream, investors might be willing to pay a little more and pay a higher price. The other thing to look for is earnings predictability. A good example of that is Wal-Mart, which has a good visible product and relatively predictable earnings. As a result, people are willing to pay a little bit more for that."
Hyman cautions, though, that looking solely at P/Es can be misleading.
"It is very dangerous to look at P/E ratios as an indicator of a stock's valuation without knowing the make up of the E," Hyman said. "A company can have negative cash flow, for example be losing money, yet have positive earnings after the company gets to add back depreciation, amortization and other accounting techniques. In a broad general sense, P/E ratios are not very good indicators of a company's valuation."
Another measure Cadinha looks at is a company's share price book value (net worth divided by the number of outstanding common shares) to see if investors have "thrown the baby out with the bath water."
"If you were to own a company and sell off all its assets corporate raider style, the return you would get would be the book value," Cadinha said. "If the price per share is below the book value per share price, a price-to-book-value ratio below 1 would mean that the stock is undervalued. But I would throw out some caution because book value is heavily dependent on a lot of things, and a company could have a low book value and be heading the way of the dinosaurs."
