World Economy: Market Troubles can be seen as Opportunities

Singapore, 18 Sep. No doubt the recent market swoon has unnerved a lot of people. It wouldn’t be surprising if pretty soon people started stocking up on rice and canned soup.

“How low can it go?” is a common refrain.

Singapore, 18 Sep. No doubt the recent market swoon has unnerved a lot of people. It wouldn’t be surprising if pretty soon people started stocking up on rice and canned soup.

“How low can it go?” is a common refrain.

I remember in my corporate finance class for my MBA when the professor gave all of us a quiz on where the stock chart of price movements is going. And in the end, he concluded that following price movement is futile. I agree with that assessment that price is not the same as value.

John Burr Williams wrote in 1938 that the value of a company is the sum of all the future cash flows generated by the company discounted back to the present.

In efficient markets, value (as defined by Williams) equals stock price. However, I am a believer of behavioral finance, i.e. people overreact in times of excessive fear or greed, and currently, we are experiencing excessive fear, and people are dumping stocks.

So in inefficient markets, value is not equal to stock price. And if you aggregate the value of the top 1,000 companies (in terms of discounted cash flow) and compare it against the stock prices, we should be able to see an interesting picture emerge. This is what Morningstar.com has done.

Morningstar.com is a ratings company. They rate whether a company is cheap to buy (5 stars) or expensive to buy (1 star). Their valuation method is strictly by free cash flow generating capability of the companies that it evaluates.

Refer to the image below. This is an aggregate of the top 1,000 stocks that Morningstar values; this is referred to as the market. A rating of 1 shows that the market is fair-valued, above 1.0 shows that the stock market price is expensive in relation to Morningstar’s valuation. Anything less than 1 shows that the stocks are cheap.

As you can see, we are living in interesting times. The all-time low was back in 2001 when the recession hit with a value of 0.78; the last 52-week low was this past week on Monday with a value of 0.82. It is currently at 0.84.

Will it go cheaper or have we hit bottom? Well, I really don’t know. No one can really tell, and anyone who makes a prognostication is probably only 50% correct. But the market is looking awfully cheap and if I had some money to spare (which I don’t), I would probably want to start nibbling at some stocks. Nibbling means not buying everything now but perhaps buying in thirds would be a good start.

Someone really smart once said, “If you don’t kick a person when he is down, then when do you kick him?”

I’ll add to that, “If you don’t buy stocks at low prices, then when do you buy them?”

Felix Eng, Independent contributor