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Stocks may look reasonably priced based on a simple P/E, writes James Montier, but this is...

Stocks may look reasonably priced based on a simple P/E, writes James Montier, but this is distorted by profit margins that are the highest ever. Not only that, but analysts' forecasts are for margins to rise even higher! A believer in mean reversion, Montier expects barely positive returns over the next seven years if profit margins move just partway back to their long-term average.
Comments (14)
  • Conventional Wisdumb
    , contributor
    Comments (1802) | Send Message
     
    If you accept his argument and gross margins are much higher than the historical norm and therefore not sustainable that does mean that PE's are no longer cheap - there will be PE expansion but it will be the earnings that decline to increase the ratio. This is one of the tenets behind Shiller's CAPE valuation methodology.

     

    This argument has been around for a while so we'll see if mean reversion actually occurs.

     

    James is one of the more lucid and insightful writers when it comes to the strategic side of investing so it is definitely worth a read.
    20 Mar 2012, 11:26 PM Reply Like
  • untrusting investor
    , contributor
    Comments (9923) | Send Message
     
    Montier is of course correct. Profit margins will mean revert, as they always do, and corporate profits will fall. This time is not different.

     

    But what is truly helpful in Montier's article is how he shows the massive impact that government deficit spending has had on record profit margins. And it is the massive government deficit spending that has boosted profit margins to record levels. Without this continued and ongoing massive government spending and massive increases in new government debt, it will be impossible for profit margins to do anything but mean revert lower.
    20 Mar 2012, 11:27 PM Reply Like
  • User 489326
    , contributor
    Comments (272) | Send Message
     
    did you say if the Republicans gain control and stop all this massive deficit spending profit margins will revert and so will the stock marker? I agree. Austerity just creates people with no money to spend to drive the economy.
    20 Mar 2012, 11:39 PM Reply Like
  • untrusting investor
    , contributor
    Comments (9923) | Send Message
     
    User,
    It doesn't even have to be austerity. It just has to be lack of massive deficit spending and massive adding to government debt. Even just a balanced government budget would have severe impacts on profit margins and corporate earnings.
    20 Mar 2012, 11:44 PM Reply Like
  • TomasViewPoint
    , contributor
    Comments (4845) | Send Message
     
    If massive government spending is the cause of our prosperity then we are screwed because that strategy has a natural end that looks similair to uhmmmmm..........Greece.
    21 Mar 2012, 12:45 AM Reply Like
  • Stone Fox Capital
    , contributor
    Comments (5786) | Send Message
     
    Everybody is missing the fact that revenue growth has been anemic. Profit margins will fall b/c revenue expands and not before. Total profits though should keep growing and PEs won't decline b/c they are already below the mean. Anybody believing in mean aversion should expect PEs to increase. Combine that with higher profits and stocks will be a lot higher.

     

    Just drives me crazy would somebody takes just one number and distorts it w/o factoring in all the numbers.
    20 Mar 2012, 11:38 PM Reply Like
  • Furbonacci
    , contributor
    Comments (370) | Send Message
     
    agreed
    20 Mar 2012, 11:42 PM Reply Like
  • Economic Analyst
    , contributor
    Comments (2376) | Send Message
     
    "Without this continued and ongoing massive government spending and massive increases in new government debt, it will be impossible for profit margins to do anything but mean revert lower".

     

    Then, with continued spending albeit increases in government "debt" (aka future commitments) made consistent with continued growth, it is entirely possible that profit margins will continue to trend higher. QED
    20 Mar 2012, 11:40 PM Reply Like
  • dieuwer
    , contributor
    Comments (2255) | Send Message
     
    What is this obsession with P/E ratios? Great stocks like Apple have traded at relatively high P/E ratios for decades. So what?
    20 Mar 2012, 11:57 PM Reply Like
  • TomasViewPoint
    , contributor
    Comments (4845) | Send Message
     
    Over time PE ratios float within a range of values so basically they don't continue to trend higher forever either for the market overall or an individual stock.
    21 Mar 2012, 12:47 AM Reply Like
  • TomasViewPoint
    , contributor
    Comments (4845) | Send Message
     
    I read the White Paper and the author does a good job of drawing a relationship between deficit spending and corporate profit margins. I would take it a step further and say deficit spending is replacing to some extent consumer demand of the UE. That is why it was so critical that Obama get all over UE from day 1 because if UE stays high then we have to run deficits or go into recession.

     

    At the same time corporations were making margins by cutting costs and primarily people. One of the charts shows margins dropping massively around 2008 and then they bounce back up as the economy righted itself a bit but corporations were cutting back hard on people which is not part of this author's analysis.

     

    My overall take is that UE has been and is the number 1 enemy of our economy and our government has FAILED massively in understanding this problem and addressing it. Germany gets real kudos for some of their imaginative programs.
    21 Mar 2012, 01:14 AM Reply Like
  • Covingtonium
    , contributor
    Comments (397) | Send Message
     
    Can somebody post a link to this paper? I would like to read it.
    23 Mar 2012, 12:29 PM Reply Like
  • SA Editor Stephen Alpher
    , contributor
    Comments (540) | Send Message
     
    The link is in the post ...
    23 Mar 2012, 12:30 PM Reply Like
  • Covingtonium
    , contributor
    Comments (397) | Send Message
     
    oops
    23 Mar 2012, 12:31 PM Reply Like
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