Value Investing Metrics Suggests Bear Market Resumption Soon

Just like the cover of my book, "Put Your Money to Work," the picture depicts a reluctant "Bear" selling his undervalued shares to the savvy investor. In due time, the savvy investor sells his shares he bought from the "Bear" to the "Bull" after the share price has risen and become overvalued. The whole "buy low, sell high" premise.

It was in my opinion that in February/March, when the sentiment was extremely dire, the market became so over sold a bear market rally was imminent.

Experienced investors would know that the market would likely rally until it got to the point when the sentiment changed and the majority of investors actually believed a new bull market was in place. The whole "be greedy when others are fearful, fearful when others are greedy" premise.

AAII investor sentiment now has 47.67% of their members who responded to their survey being bullish, 31.4% bearish and the remaining 20% neutral. I would put that in the category of "majority believing we are now in a bull market." 70%+ were bearish around the March low.

I want to draw attention to valuation metrics. I will use Starbucks (SBUX) as my example. Here is a 2-year weekly chart from bigcharts.com.

click to enlarge

In April of 2008, I wrote about SBUX here on seeking alpha. Toward the end of the article, I wrote the following: "It is in my opinion that many of the earnings forecasts of corporations are too high and are not factoring in these "recessionary times." and "The best part about the "adjustment" in share prices we're seeing is that over the coming quarters and years, many great companies may very well become great values. Just how low will Starbucks go before it bottoms is anyone's guess."

SBUX was estimated to earn $0.97 per share for fiscal year ending Sept 2008 and grow their earnings 18.3% per year over the next 5 years in April of 2008. Clearly, that was overly optimistic. Instead, SBUX earned .67 per share in fiscal 2008 and that included a .24 gain from "unusual income." As we can see from the chart above, SBUX share price continued to fall as those earnings expectations were simply not met.

7.07 per share in November of 2008 marked the bottom. SBUX also went below 9 again in March of 2009.

In today's valuation metrics, a fair present value of SBUX earning .76 per share this year and growing earnings 15.25% per year for the next 5 years would be around $10 a share per my analysis.

How I came to $10 per share is by taking what analysts believe they could be earnings in 5 years from growing earnings at 15.25% per year ($986 million) and then putting a P/E of 10 on the share price to come up with a future value, ($9.86 billion) then discounting it to a present value, which gave me around $10 a share. Because the liquidation value of SBUX is only around 3.56 per share, investors are paying too dear a premium for Starbucks at around 17.70 per share.

I'm confident Starbucks will be an ongoing business operation for years to come with coffee houses all over the world. Liquidation is unlikely, but the premium over liquidation needs to come down in the future. P/E of 10 because they will be likely to grow earnings only 5% -10%, that would give them a PEG of 1.0 - 2.0, which I consider sound.

Savvy investors who were focused and smart enough to buy shares from the "Bear" in November or March can now consider selling to the "Bull" and wait patiently for the next time the bear rears its fierce claws and takes down stocks again.

In summary, I believe the "Bull" is back in this market and taking profits now is prudent.

Disclosure: No position in SBUX

Comments

[AndrewBaker:]

A nice way to put things as they stand right now. The few (long) stocks I still own, I will gladly sell to the bull as soon as the price is right, and the money will sit in a very low interest paying account waiting to be put to work on some choice shorts; not least of which will be financials and banks especially.

I will, though, hold some commodities as well, being gold and natural gas in particular. Come next year, those measures will see me looking pleased, and also looking at today's bulls crying, wondering what happened.

Aug 03 01:29 PM

[happytrader:]

yeah, profit taking is just matter of time. Some other stocks like PCU, and CAT also very similar. People are trading at its Future PE and not current, what if the analyst are wrong in their future estimate. Three is no room for error, it will drop fast. Thanks for the reminder. I better take my profit off the table.

Aug 03 03:06 PM

[BPYHO:]

This scenario might begin tomorrow if the Employment #'s are worse than predicted.....

Aug 03 06:19 PM