Top fund manager Bill Nygren says that valuations don’t look bad in the stock market, and in his second-quarter letter he offers a few reasons why investors are mistakenly viewing stocks as pricey.
Nygren says that using forward earnings estimates, the S&P 500 sells for about 15 times earnings, “which suggests to us neither unusual opportunity nor risk.” So why are so many investors talking about excessive valuations? The first reason involves those who have missed out on the bull market thus far. “The speed of this stock market recovery has made it especially difficult for those bears to admit their mistake and get invested again,” he writes. “Instead of viewing March 2009 as an anomaly (we look back on it as a once-a-generation buying opportunity), they cite the unsustainable increase since then as a reason to remain on the sidelines.”
Secondly, Nygren says, “Many of the stocks that now have low P/Es on expected earnings are financials, and after their role in the crisis, many investors, including many value investors, have completely sworn off owning them.” But he says financials are in a much different place today. “Today, financials are less levered, they have tighter underwriting standards, and most importantly, they do not seem likely to face another crash in real estate prices,” he says.
The final reason Nygren examines is the notion that besides financials, little else is cheap. He says it’s true that while overall valuations are reasonable, there aren’t a lot of low-P/E non-financials. But he says that doesn’t mean there isn’t a lot of opportunity. “Though we too are always looking for average businesses at great prices, we believe the tight P/E distribution creates a different opportunity,” he writes. “When the market is pricing everything as if it were average, we’ll happily buy great businesses. To us, buying great businesses at average prices is just as much value investing as is buying average businesses at great prices. So we see opportunity today in the other half of the distribution — companies selling at a smaller premium than usual. Investors today aren’t asked to pay much extra to own businesses that we believe will enjoy long periods of above average growth.”
Nygren also talks about the reasoning behind his recent purchase of Amazon shares.