Re: [Slate] Insane in the Brain:

Dave Long (
Thu, 01 Apr 1999 19:58:04 -0800

> A P/E of 26 on the S&P500 -- up from 15 a decade ago -- means that in
> the current environment of .6% profit increases and 2.75% inflation, that
> a share of SPY represent over two decades of future earnings.

I have a copy of Graham and Dodd, _Security Analysis_, from 1962, which has
several interesting points.

"In 1928 the thinking of common-stock "investors" had become indistinguishable
from that of speculators; the only practical difference between them was that
the former may have paid cash for the same stocks that the latter carried on a
thin margin."

"The only quantitative factor that remained was the specific rate of growth,
either historical or projected. But while this concept might lead the
investor to the "best" companies, it could not possibly protect him against
paying too much for their shares. On the contrary, the acceptance of the
growth-stock principle as the only guide to investment made the payment of
excessive prices its inevitable consequence."

"Thus it is to be stressed that common-stock buyers have historically demanded
an additional return *except* in the upper stages of bull markets, at which
times the public apparently became fully conscious of the great intrinsic
merits of common stock. When the bull market was over the public always
returned to its perhaps unreasonable demand for a higher current income from
representative stocks than from bonds."

"The hazards attaching to undue enthusiasm for the best-quality companies are
illustrated by the recurrent overvaluations of General Electric common in the
bull markets of the past three decades. ... Since 1929 the declines in this
high-grade issue have been on the order of 93%, 68%, 35%, and 39%. Equally
significant is the fact that the 1929 high was not reached again until 25
years later. The high and low prices made by the DJIA as a whole during this
period reproduce, within somewhat narrower limits, the behavior of investors
toward General Electric."

Anyway, a P/E of 13-15 is what they considered sound in 1962. It would be
interesting to see how that figure fluctuated with different editions
('34,'40,'51,...) and with the benefit of hindsight.

Those who are even more conservative than Graham and Dodd point out that
return on capital can be of little value if one has cause to be worried about
return of capital.

> Me? I'm thinking 1982.

How about the early 70's? I understand that blue chips and mutual fund
managers were popular in the late 60's. Does anyone have Mr. Lynch's quote
about cocktail parties?

> Cal munis make a difference. At 6% tax-free, that's effectively 8.5, 9%.
> If no one pulls an Orange County bankruptcy, that is.

Is this a case of "gentlemen prefer bonds", Rohit? In the upper brackets, CA
and the feds take ~50% at the margin, so for the taxpayer with a bit of the
ready, that's more like an effective 12%: in the ballpark of the average
return for US equities this century at much lower risk.