Independent Investment Advice Blog

Bear Vs. Bull Case: Independent Financial Advice

     The Bear versus Bull case for stocks could be summed up as a debate about whether to use the current Price earning (PE) ratio versus the ten year inflation adjusted average PE ratio. The Bulls claim that the ten year average of earnings is 70% of current trailing earnings, so they claim the ten year figure misses important data.

   My response to that is that first one needs a filtering mechanism to get a clear unbiased view of earnings, so taking a long term inflation adjusted average of earnings is one way to do that. The problem with using current trailing earnings is that a company can go through a temporary growth spurt that is unsustainable due to some faddish product or due to some unethical accounting trick that will be found out in a few years. Look at all the tech companies that were hot for a few years and then faded into obscurity.

     Further, current earnings as a percent of GNP are unusually high. This is due to either tech companies with temporary spurts in product popularity or to companies using foreign subsidiaries in tax haven locations, which reduces, taxes thus raising corporate after-tax profits. This is unsustainable and dangerous because Congress could easily take this away. The IRS has already cracked the nut of foreign bank accounts by gaining cooperation of Swiss Banks, etc. So it seems logical that eventually Congress will change the corporate income tax to outlaw foreign corporate tax shelters. This alone could dramatically reduce corporate income.

Open the secrets of investing

    When evaluating investments one must examine risk and part of risk are unsustainable corporate earnings that are artificially and temporarily too high. That is why the responsible way to invest is to examine earnings for sustainability and one of the best ways is to examine the long term average, adjusted for inflation. The component of a corporation’s earnings that has jumped at an exceptionally high percentage is analogous to a little small cap company that is undergoing a sudden growth spurt: they both have high risk of faddish unsustainability. The small cap component of a successful large cap stock should be carefully evaluated as a source of hidden risk that can lead to sudden disappointment. Using a ten year average of earnings helps to filter out incorrect information.

     I wrote an article “Three bear market strategies you must know”.

     Investors should seek independent financial advice.