Walking the High Wire
by Steve Visscher, Mawer Investment Management
Many of the worldâs stock market indices are near, or have recently set, all-time highs. These developments have been well-documented in the media, with most references containing cautionary tales of the declines that occurred each time markets had previously reached these levels. This has left some investors questioning whether owning equities at such âloftyâ levels is still wise. Should we take our profits now and avoid the inevitable declines?
This course of action may seem logical, but is it?
A chart of the S&P/TSX Composite Index or any other equity index provides a visual tool to summarize past and present price movements, but it reveals nothing about the attractiveness or investment merit of the companies that comprise the index. To do that, we build forward-looking estimates of the level of cash flow that each company in our portfolios can generate. This, rather than a stock chart, becomes our tool to assess whether companies are trading at attractive or excessive values.
This focus on future cash flow or future earnings (a more common metric reported in the media) is strangely absent from much of the current coverage on the record-breaking index levels. For example, the S&P 500 has recently surpassed its value during the market peak in 2000. At that time, the 500 companies in the S&P 500 were trading at about 25 times future earnings. Today, that ratio is closer to 15. Put another way, the current value of these 500 companies is about the same as the value in 2000, but these companies are now generating earnings that are approximately 66% higher.
When was the last time you read a headline noting the record-breaking level of earnings?
We arenât suggesting that equities wonât suffer a pullback from current levels; any number of developments could be the catalyst for a correction. But in the long-run, the attractiveness of any given company is not related to what it looks like on a historical chart, but is correlated to its current valuation and its ability to generate future cash flow for shareholders. We would encourage investors to stay focused on these metrics and not historical charts.
Steven Visscher
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