I’m sure you don’t need me to tell you what mood the market’s in. Borderline panic is probably as good a description as any. I may not like the panic, but as a value investor I do like the bargains it throws up and one such bargain may well be the FTSE 100 itself. If I flick across to Google Finance the FTSE 100 stands at 5,036. If I were a technical trader then I’d probably say we might find some support at 5,000, but not much. If I were a TV news anchor with red braces then I might say “the FTSE 100 closed just above 5,000 today, which is where the index stood in 1998”. Since I’m a value investor who lives in Graham and Doddsville I prefer to start by looking at the ratio between that 5,036 level and the FTSE 100’s earning over the last 10 years.
PE10, friend of the long term investor
One of the many tools bestowed upon the investment profession by Ben Graham was PE10, or the current price over the average earnings of the last 10 years. There isn’t anything magic about looking at 10 year earnings averages (in fact 30 years may be better), but it sure is a step in the right direction compared to looking at the current PE.
Graham felt that for ‘leading enterprises’ the last 10 year’s earnings may be a reasonable estimate of the next 10 year’s earnings. With many large, established companies their earnings do fluctuate around a certain level or magnitude, and so using the past to estimate the future is not as whacky as it might sound.
The same idea can be applied to the market as a whole since the FTSE 100 is effectively a collection of ‘leading enterprises’. In fact I’ve written before about various approaches to valuing the market as a whole and even included a mathematical function for calculating stock and bond allocations.
If you want some empirical evidence then the excellent “Valuing Wall Street” and “Wall Street Re-valued” by Andrew Smithers provide a solid grounding in this area.
Put simply, the earnings of the FTSE 100 (UKX) are relatively stable over longer periods. As the years tick by the 10 year average increases (most of the time) at a fairly predictable rate. In turn, the market…
