Tagged: S and P 500

The Theory of Value Relativity

There’s an old stock market joke. Every time one person sells, another buys, and they both think they’re smart.

Value is relative. And yet. Anybody in the IR chair pencils valuations for his or her shares. Isn’t this the battle – measuring value? Karen and I on a recent trip sat with a sharp IR pro who explained how the team had an internal valuation model for company stock.

Many consider historical price-to-earnings ratios of the S&P 500 (about 16 over 130 years but ranging from below 9 in 1933 and 1983, to 40-plus in 2000, the record). Some like the S&P earnings yield versus 10-year Treasurys (7% to 2%). On that basis, markets would seem to be a whopping good buy.

And yet the Dow was down 500 points in five days through Tuesday.

There are three immutable valuation meters. You’ve got future value of cash flows. For instance, somebody at Facebook determined that Instagram’s future cash flows discounted to present value are worth $1 billion rather than the current figure of zero.

There’s net worth. When Microsoft bought AOL patents this week for $1 billion, the market added the cash to AOL’s net worth and shares shot up about 20%. (more…)