Stocks Aren't As Cheap As They Seem

I wrote the following article (subscription required) for Barron’s February 4th, 2008 issue. It is a partial, updated excerpt from my recently published book Active Value Investing: Making Money in Range-Bound Markets.

The thesis of the article is as follows: Today’s corporate profit margins are very high. They’ll mean revert (i.e. decline) as they always did in the past (in the article I provide the reasoning). Earnings will either decline or grow at slower rate than GDP. If you think stocks are cheap, they actually aren't once you normalize earnings for super high profit margins. Make sure you own companies that due to their competitive advantage and favorable industry structure can maintain their profit margins.

The following two charts really tell a great story about profit margin compression overtime. Due to readers request I created one based on GDP and one based on GNP.

Readers asked me to see if the original profit margin chart would look differently if used GNP (national product) instead of GDP (domestic product), as you can see from this chart, there is no difference, you cannot tell these charts apart.

[click to enlarge charts]

Comments

[Reinko]

Nice article; I already knew some estimate upon total profits of the US economy and the above graph says it all.

And when you know that the total debt of the US economy upon herself is above 50 trillion and that the US economy as a whole will try to pick up another 8 trillion in 2008, you see with easy that the interest paid to stabilize this debt is about 2.5 trillion or 2500 billion.

This is above total profits of the US economy so it is proven once more: The US economy is a so called Ponzi financial unit.

That means paying the interest can only be done by picking up more debt...

See the FED flow of funds sheet for the details and calculate them for yourselves, here is the link:

www.federalreserve.gov...

[granger]

Good info, thank you