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Is it Really That Easy?

For the past 29 years, Forbes Magazine has published in a special edition a list of the 400 wealthiest Americans. Included in this year’s edition (October 11, 2010) are some “fun facts” about these individuals. Mark Zuckerberg, the 26 year old founder of Facebook lives in a rented house and loves to barbecue in his back yard enclosed by a chain link fence. Oprah Winfrey earned $1.35 Billion in the past five years and is ranked as the 130th wealthiest American. She would probably be a bit higher in the rankings however, if it wasn’t for her frequent giveaways like taking 300 members of her audience on an 8-day trip to Australia.
Found within the list are also a number of hedge fund managers, including the 62nd wealthiest American, David Tepper. Mr. Tepper is the manager of the Appaloosa and Palomino hedge funds that have approximately $15 Billion in assets. Beginning in 1993, the Appaloosa fund has averaged a 30% annual return net of fees. Given the cost structure of most hedge funds, we would estimate the gross return to be close to 40% per year. 
With a record like that we should pay attention to his thoughts about the markets and common stocks. It was in a recent interview that Mr. Tepper stated his decision to own common stocks today is easy. He says the economy will improve by itself, or the Federal Reserve will step in with a new round of quantitative easing. If the economy improves by itself then stocks will be higher a year from now and you will make a lot of money. If the Fed begins a new round of easing then everything will be higher a year from now except long-term bonds and you will make a lot of money. In other words, own common stocks and you will make a lot of money.
How much can you earn? Obviously no one knows but there are a couple of thoughts that I will share with you. The S&P 500 is trading at 12x estimated forward earnings and offers a 2% dividend yield. The historical earnings multiple has been closer to 15x. If the economy improves on its own, or if the economy improves with help from the Fed, then it is easy to see multiples expand, even without earnings growth. An expansion in multiples from 12 to 15 is a 25% increase in valuation (15-12/12), with that dividend on top for good measure.
Maybe it really is that easy.

Disclosure: No Positions