2010 - THE YEAR AHEAD
Expectations for the year ahead are all over the map. Generally it is good to hear so many divergent economic and investment opinions to help build a wall of worry among investment managers. The old adage on Wall Street says “the market loves to climb a wall of worry”. A growing wall of worry creates one of the best investment environments for equity investors. With that said, the best standard measure by which all markets are gauged is total return. So our expectations will be based on a total market return basis and the underlying fundamentals and valuation of each security we own.
Large Capitalization, Small Capitalization or International stocks are always questions asked by investors to determine the better investment theme. In our opinion the most important aspect of a good investment is not the theme, sector or country of origin but the individual company and its valuation. Valuation is the most important aspect of making the proper investment and is the main determinant in our investment thesis. With that said we also look to the markets solely as a valuation device that helps us in determining the markets valuation and our investments valuation. The markets valuation not direction is most important in determining potential for total return.
Simply put, there are three components to total stock market return - earnings growth, dividend yield, and changes in valuation. Earnings are the underlying determinant of value for a stock or stock market. Thus as earnings grow, so too does value. Historically, corporate earnings have grown in line with nominal GDP, or about 7% per year. But over the next few years, we are looking for a somewhat lower-than-average 5 to 6% earnings growth due to the top-line pricing pressures of a higher inflation and an increasingly competitive global- business environment. As for dividends, the current yield of the Standard & Poor's 500 Stock Market Average is slightly less than 2%. So excluding changes in valuation and ignoring the interim fluctuations, we can look forward to 7 or 8% stock market returns, longer term.
Our bottom line expectation is 6 to 8% stock market returns over the next five years or so. And we think those returns will compare quite favorably to the rate of inflation as well as to the returns produced by most stock market alternatives. The returns available on cash and cash equivalents, for instance, remain below the rate of inflation. Commercial and Residential real estate appears to us to be quite richly valued currently. And we continue to view the bond market as unattractive at this point in time.
In conclusion, with our expeditions for 6 -8% returns for the years to come we continue to focus on owning the companies that exhibit top line and bottom line growth and show healthy increase in operating cash flow
