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Stock Talk

Legend Financial Advisors, Inc.®
5700 Corporate Drive, Suite 350
Phone: (412) 635-9210

Lou Stanasolovich
  Lou Stanasolovich, CFP®
  CCO, CEO and President

Are Stocks Overpriced And Forming A Bubble?

Invented by the 2013 Nobel-prize-winning economist Robert Shiller, the Shiller PE is a widely-watched measure of the stock market’s health, and it recently turned negative, indicating the U.S. stock market is overpriced and ripe for a fall. Should you worry?

As the stock market was soaring to new highs just before the start of 2014, the Yale University professor’s key barometer of the stock market value rose above 50%, indicating that stocks were overpriced.  While disagreeing with a Nobel economic laureate’s opinion on investing is an unenviable position, the negative signal from the Shiller PE is a statistical aberration, an anomaly caused by the recency of the worst financial crisis in generations.

The Shiller PE uses a 10-year average monthly p-e ratio as the denominator in an equation measuring whether stocks are expensive.  This period includes the 2008-2009 financial crisis, a once-in-78-year economic and financial occurrence.  Including that once-in-a-lifetime event in a 10-year average PE calculation skews the numbers unrealistically toward the negative.

Stocks are actually trading at a reasonable level by most measures.  While some of the financial talk shows on TV have been saying stocks are in a “bubble” or even overpriced, much evidence exists to the contrary.

To see what a stock-price bubble looks like, look at the figure above.  It tracks the price of the Standard & Poor’s 500 index — a measure of America’s blue-chip companies — versus actual and projected corporate earnings on the 500 companies in the S&P 500 index.  The gap between the black line, which represents stock prices, and the green line, which represents earnings, depicts the growth of the tech-stock bubble from 1997 to 1999.  The correlation between the S&P 500 and stock prices broke down in the tech bubble. No such breakdown is occurring now.

Another key measure of whether stocks are overpriced is shown below.  The two green lines represent the historical trading range of stocks during a benign inflation environment like we have been in for the past few years.  The lower green line shows where stocks would have traded if investors had valued stocks at $15 for every dollar of profits on companies in the S&P 500 index, while the upper green line shows a multiple of 17 times earnings. You can see how the price of the S&P 500 shown in black became disconnected from corporate earnings.

What’s it mean for stocks in 2014?  The red lines at the end of the green lines show forecasted earnings for the last quarter of 2013 and 2014. Estimated 2013 and 2014 bottom-up S&P 500 earnings per share as of October 31, 2013 was $109.67 for 2013 and $122.06 for 2014.  Past performance can never be taken as a guarantee of future results. However, if the consensus earnings forecast is accurate and nothing unexpected happens to derail corporate earnings, stocks would be dragged higher based on how investors valued stocks in recent months.  As 2014 was about to begin, and with stocks trading at 15.9 times 2013 earnings, the price of the S&P 500 was well within its historical valuation norm and talk of a bubble seemed unwarranted.

4 Steps To Creating A Dynamic Business Budget

Most business owners and high-ranking corporate managers recognize the importance of developing a budget that reflects expected income and expenses for the coming year. But even sophisticated projections aren’t likely to take into account all of the potential calamities, cash-flow problems, employment issues, and other events that might occur. Another problem is that business people often create budgets at the beginning of the year and file them away for months. By the time the end of the year rolls around, it may be too late to make any meaningful adjustments. 

Of course, your business isn’t static, so your annual budget shouldn’t be, either. The trick is to create a budget that is dynamic and can be modified easily while still standing the test of time. 

Start with the basic premise that virtually every business needs a budget. In its simplest form, this is a detailed plan showing expected future costs and receipts. Not only can your budget help you manage your business expenditures, it also can help determine whether and when your profit objectives are in reach.

Your budget can put you on the right track and give you greater control. For instance, by examining your projected budget for the next quarter, you can anticipate peak periods and schedule inventory purchases and labor to handle the expected sales volume. In addition, you can factor in vacations, marketing plans, and various other activities. Developing a budget is a proven method for running a successful business and you should not be without one.

Here are four practical suggestions for going beyond the basics:

1. Review the budget on a monthly basis. To have your budget be truly dynamic, you should revisit it more than once each quarter—at least once a month is preferable. Include the key players on your management team and update the budget based on the company’s performance during the prior month. Don’t ignore significant numbers that may be indicating a trend. Are you sufficiently stocked to meet sales forecasts? Are there signs you will need to trim the staff or hire more workers? Are receipts and expenses in line with projections, or do you need to cut back or press ahead in certain areas? Getting answers to all of these questions is vital.

2. Implement changes that will have a positive impact. After you’ve conducted your monthly review, it’s time to assess the situation and make any appropriate changes. Focus on steering the business in a positive direction. Then wait to gauge how the changes affect your income and expenses month to month and year to year. For example, if you have been underutilizing your marketing resources, adjust your budget and chart the results over both the short and long term. During your next review session, determine whether you’re receiving a favorable return on marketing dollars spent per sales lead. Use this information when planning how best to allocate your costs for the future.

At the same time, don’t forget to examine receivables. Is there a way you can speed up your invoicing procedures and payment cycles to improve cash flow? Are you doing enough to chase down deadbeat accounts and late payers? 

3. Respond promptly to unexpected events. If there is one thing to learn about business budgeting, it’s to expect the unexpected. Your budget needs to have the flexibility to accommodate whatever comes up. Suppose your top client suddenly goes out of business or drastically reduces its purchases. Take a look at your budget and see how this drop-off in revenue would affect your cash flow. Can you find replacement income and how long would that take? What would it cost you in terms of marketing or hiring additional personnel to help bring in new business? Adjust the budget accordingly and move on.

4. Use incentives in the budget process. A good way to get everyone on board with a regular budget review is to tie bonuses to the practice. This is accomplished best at the beginning of the year when you create initial projections. Typically, you’ll establish parameters based on performance, but you also might set up rewards for return on investment from marketing, keeping expenses at or lower than projections, and other objectives. Think outside the box to keep the business humming in good times and bad.

Of course, a better business budget is no absolute guarantee of success. But you can improve the odds by being diligent and responsive throughout the year.

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