By Dan Ferris in Extreme Value:
I don't use relative valuations. For example, I don't think a stock is necessarily undervalued if it's selling for 18 times earnings and its peers are all selling for 25 times earnings. But I still have to wonder what Mr. Market is thinking in this regard.
The overall market is selling for 32.5 times earnings per share. And yet, Berkshire Hathaway sells for 18 times estimated 2010 earnings per share, Microsoft for less than 15 times, Dun & Bradstreet 14 times, and Philip Morris for less than 14 times. All of these companies are unquestionably above average. They're some of the greatest businesses in history. And yet their valuations remain stubbornly below the general market level in the biggest stock rally since 1933.
Even if you account for the lower valuations that rule in the sideways market, these companies are worth plenty more than where they're trading today. In a sideways market, I'm saying they're worth at least 20 times earnings. In a secular bull market, everyone would readily acknowledge they're worth 25-30 times earnings.
I think the discrepancy between what they're worth and what they're trading for is due in part to the perception that you can't make any money on big-cap stocks and in part to the desire to "follow the trend" and ride soaring garbage stocks higher. Careful you don't fall into this trap. It strikes me as a bad idea to remain willfully ignorant of business valuations when buying and selling businesses. If you believe in letting the thundering herd tell you what to do with your hard-earned capital, just be careful you aren't still following it when it runs over the cliff.
Crux Note: Dan Ferris is the editor of Extreme Value. For serious investors, Extreme Value is one of the best advisories you can buy at any price. If you're not already a subscriber, you owe it to yourself to
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