Taking Stock

Tony Crowell
Tony Crowell

Old Pilots and Bold Pilots

Apple (AAPL-$100) kicked off the fall stock season with a trio of new products. Its new iPhone expands the screen and the iWatch shrinks it. Apple will sell millions of these to people who didn’t know that they really wanted them until this week. The iPay system is less dramatic but will gain quicker adoption. It enables consumers to buy things more quickly, another previously overlooked need, while adding features such as an ability to incorporate loyalty “points” or other credits with cash in a transaction.

Usually, critics complain about Apple’s new products with sufficient shrillness to take a few points off its stock price. Its latest innovations stopped the whining while building confidence that its CEO will be able to maintain the magic begun by the late Steve Jobs. This is a remarkable company, whose stock yields 2% before next year’s dividend increase, while selling for 16 times earnings, less than ordinary stocks.

Overall valuations on earnings remain a factor of possible concern. Robert Shiller’s “CAPE” index, which divides current prices by earnings over the past ten years, stands at an elevated level of 26. As I have written before, this index is somewhat distorted by its inclusion of the below average earnings precipitated by the Financial Crisis. As subsequent record high corporate earnings are increasingly included, this index will moderate, although its cautions must be noted today.

Warren Buffett often cites another index that compares corporate total market caps (stock values) to the current Gross Domestic Product. Still another, the Tobin Q Ratio, compares the same total market caps to total book value, the theoretical cost of replacing business assets. Both these ratios, like the “CAPE” index are at elevated levels, indicating an increased probability that prospective stock market gains may be limited to single digit ranges.

All these indices will moderate if corporate profits continue to set records. A concern is that profit margins are also at all-time highs. High profit margins invite competition, which may squeeze margins, lowering earnings and pressure stock prices.

This brings up interest rates. Rising rates, whenever they return, lower the discounted value of future earnings and dividends. It is hard to imagine rates going much lower than they are now, even though they have defied predictions of imminent rises for over a year. The Federal Reserve has already begun pulling back and only two of its seventeen officials responsible for setting the federal funds rate believe it will not rise until 2016.

Regardless of when rates rise, many investors will be surprised and the market has lost an average of two percent in the month following the Fed’ announcement. These factors are all based on market history and should not be viewed as short-term market forecasts. As John Kenneth Galbraith said, “We have two types of forecasters. Those who don’t know and those who don’t know they don’t know.”

Even so, “investors” will always try to find short-term fortune telling. This explains the popularity of financial television and purchases of stock market prediction newsletters, similar to those sold to those who favor horse racing or even buying lottery tickets.

Acting beats guessing. There are enough signs of possible overvaluations after five years of excellent stock returns to suggest getting off margin, if used at all, and building up modest cash reserves to take advantage of possible dips. Steadier performers will include Amgen (AMGN-$138), Blackstone (BLK-$328), Disney (DIS-$89), Ecolab (ECL-$114), Google (GOOG-$577), Intel (INTC-$34), Novo-Nordisk (NVO-$46), Thermo Fisher (TMO-$122) and Union Pacific (UNP-$107).

Hiding from risk is not a solution. Someone who sits down at a poker table with a priority of playing not to lose is unlikely to win. The U.S. Navy doctrine of “calculated risk” works well in investing. Naval aviators defined this: “There are old pilots and there are bold pilots but there are no old, bold pilots.”

Tony Crowell manages stock portfolios for individuals and their trust and retirement accounts with CROWELL•ROBERTS Investment Counsel, a registered investment advisor in Laguna Beach since 1995. [email protected] 949.494.1376/800.697.2622




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