Stock Market: Value Versus Reality

Reality wins. Every time.

When looking at this relationship, we can get caught, as many have before, looking at the reality of the market and wanting to believe that there will be a capitulation followed by an understanding of where valuations are and what the opportunity for profit is currently. Value investing often finds itself at “odds” with reality in the near term, although to a value investor, this contrarian situation is the whole point of the exercise. It creates our opportunities, but can, at the same time, repulse us in the process.

Stock Price ActionLooking at our rudimentary drawing of stock price action, and the relationship that we see between fear and greed, we are left with an uncomfortable truth. In today’s market, this relationship is heavy on the fear and a bit light on the greed. We know that the majority of stocks are trading in fairly undervalued ranges given their historical norms. However, this is being greatly overshadowed by the weighty nature of fear. What is good is that this is nothing new, and it can be expected to continue for market fluctuations into the future.

Looking at our historical percentages of “Under” to “Over” valued stocks, we can see that as the S&P 500 has had its dips, our percent of “Under” valued ratings increase significantly. This is the case with the current market. The big question is whether or not the relationships of value, fear, and greed will continue to operate in the future as they have in the past. Historically speaking, the transition from a positive (Greed) sentiment environment to a negative (Fear) takes a long time, but the transition from negative to positive sentiment has taken exponentially longer.

Or are we in some new environment? Where fear becomes the dominant factor for an even more extensive period of time? As one great commentator recently pointed out, are we headed back to a time where stock yields significantly outpace bond yields to more appropriately reflect the inherent risk in equity versus debt securities?

At Ockham, we don’t believe that this is some new alter universe where fear forever trumps greed. Stocks may continue to stay depressed longer, given the far reaching reality of a global economic recession. However, the basic principles of investing will continue to hold. Right now, what we are witnessing is the natural occurrence of emotionality in stock price action that occurs as valuations shift and adjust to reality.

Ratings ChartSo the bottom line is, value doesn’t fight reality. Value is reality. Time will ultimately demonstrate this unequivocally, as it has in the past. In times like these we refer back to the father of value investing, Benjamin Graham, who said:

“In the short term the market is a voting machine, in the long-term it is a weighing machine.”

About Ockham Research 645 Articles

Ockham Research is an independent equity research provider based in Atlanta, Georgia. Security analysis at Ockham Research is based upon the principle known as Ockham's Razor, named for the 14th- century Franciscan friar, William of Ockham. The principle states that a useful theory should utilize as few elements as possible, because efficiency is valuable. In this spirit, our goal is to make the investing environment as simple and understandable as possible, yet no simpler than is necessary.

We utilize this straightforward approach to value over 5500 securities, with key emphasis given to the study of individual securities' price-to-sales, price-to-cash earnings and other historical valuation ranges. Our long term value investing methodology is powered by the teachings of Ben Graham and it has proven to be very adept at identifying stock prices that are out of line with fundamental factors.

Ockham Research provides its research in a variety of forms and products including our company specific reports, portfolio analytics tools, newsletters, and blog posts. We also offer a white labeling research solution that can give any financial services firm their own research presence without the time and cost associated with building such a robust coverage universe of their own.

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