Meltdown ... and finding cheep stocks
Okay, so it's October 10, 2008, and the S&P500 is down 38% year-to-date.
It should be a good time to look for cheeep stocks, eh?
>Yeah, but how do you measure "cheap"?
>Don't tell me! You got a spreadsheet, right?
Aah, that's the question ... so I consider things like:
Yes, and it looks like this:
>So what are you buying?
>But look at them shipping stocks! P/E and PEG ratios, Price/Book ...
>But a P/E less than 1? Have you ever seen that before?
Not that I can recall ... but P/E depends upon past Earnings.
What I like even better is Price/Book.
But then the 1-year target prices are interesting, eh?
Just think if that target were actually achieved!
You'd have (for example) a gain of 300% or 400%. Mamma mia!
>But them shipping stocks are unpredicatble, ain't they?
Uh ... yes, they're quite volatile.
>A volatility greater than 100%? Have you ever seen that before?
Not that I can recall ... but it's calculated using the volatility of daily returns then multiplying by SQRT(250).
>So you're recommending them?
You kidding? If I recommend they're sure to crash!
>So what are you doing?
Will History repeat itself?
Here's a fun exercise:
- Look at the past umpteen years of the DOW.
- Find a year where the drop was dramatic (as it's been this year).
- Imagine what'd happen if the DOW performed in the near future as it did in that historical year.
>You can do that?
Sure. There aint no law ag'in it. Did you see the most recent DOW drop, in 2002? Down over 20%.
Here's the comparison:
A $1K investment in the DOW, in the recent past,
compared to the performance starting April 8, 2002.
The near-future DOW (beginning Oct 10, 2008)
if it imitated the 2002 performance.
>But the past is no ... uh, how does it go?
Past performance is no guarantee of future results? Is that what you mean?
Didn't I say this was a fun exercise?
Okay, suppose we look at the recent past for the S&P500 and ...
Future: a replica of the past (?)
>The recent past? Why?
Just in case somebuddy says: "This time it's different".
Anyway, suppose we look at the performance of the S&P500 this century: Jan, 2000 to Oct, 2008 (monthly):
Now we extract the Mean Return and Standard Deviation from that data and predict the next ten years using a classy technique due to Ito.
The red line is where we are now: S&P = 946:
>Probability Density? That means nothing to me. How about ...?
Okay, here's the probability that the S&P500 will be less than P in 10 years (or 120 months):
>What?! There's an 85% probability that it'll be less than it is now?
Actually it's an 86.42% probability ... and I can give you more decimals if you like.
>And you really believe that stuff?
What I believe is that the past gives only vague insight into the future. One needs a more sophisticated tool, like this.
However, suppose we wanted to look carefully at the past and see how long we'd have to wait to get, say a 7% Compound Annual Growth Rate.
We can consider the annual returns from 1928...
That's just an example ... now let me continue.
We consider the annual returns from 1928 to 2007 and calculate the Minimum CAGR over all N-year periods and the Maximum.
We'd get this:
>So if I wait 25 years I'm guaranteed to get at least 7.4%?
In the past. Actually, from 1928 to 1953.
That was the worstest 25-year period. The bestest was 1975 to 2000 where you'd have got over 16%.
However, we haven't included inflation, so the "real" returns would have been less. **
>So do you think I'll get at least 7.4% in the future?
You can borrow this
** If we include inflation, we'd get this:
>Well ... maybe I should just wait longer than 25 years, eh?
If you wait N years your minimum CAGR would look like this: