Crucial Differences Compared With 1929
Q A TV news broadcast the other day compared the current stock market to that of 1929. That makes me nervous about buying stocks. Are market fundamentals, such as price-to-earnings ratios, as high as in the late 1920s? Could a market crash produce another Depression?
A Stock experts traditionally use three gauges to determine market valuation - earnings, book value, and dividends - says James Stack, president of InvesTech Research, Whitefish, Mont.
"All three valuation gauges are higher now than they were in 1929," says Mr. Stack.
Depression? Not likely.
Many safety nets exist now that were not in place in 1929, Stack says.
The Federal Reserve, for example, now has greater ability to prevent the price deflation that occurred in the 1930s. Unlike then, the Fed now has shown a willingness to flood the banking system with money during a severe market downturn.
Where to invest? Find a comfort level for your stock portfolio, where a major downturn, even 50 percent, would not be totally debilitating for you. For new investments, Stack likes out-of-favor alternatives, including beaten-down Japanese equities.
Q In evaluating certain stocks, I take into account the amount a company spends on research and development. I examine R&D values with respect to net earnings and then make an adjustment to the price/earnings (P/E) value accordingly. Here's an example: Based on 1996 corporate earnings, Emerson Electric has a P/E of 22. But with R&D spending, the P/E drops to 14. This procedure only applies to companies with large R&D budgets. Does this make sense?
Vero Beach, Fla.
A Your approach works "for many R&D-intensive industries, such as pharmaceuticals, some consumer electronics, and technology-related companies," says Ken Shea, director of research for Standard & Poor's Corp, New York.
But why stop there? he says. You could also adjust the P/E for accounting practices such as depreciation or for corporate "goodwill."
"Financial analysis is not a science, it's really an art," says Mr. Shea. But the goal is always to get a precise value of a company.
Questions about finances? Write:
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