Look out — I'm reading about why we should raise the average PE ratio on stocks because it may be too low. What I’m reading is that over the past 25 years, the U.S. market has remained above its historic PE valuation.
The argument goes on to say that maybe advisers should factor in a new, higher valuation. If one looks at the range from 1870 to 1980, the PE was a low of 7 and a high of 21 times, based on the trailing 12-month earnings per share, or an average of 14.
But since 1990, the mean valuation of the trailing 12-month PE ratio is up nearly 50 percent.
So the new average PE they are arguing for is 20 times on a 12-month basis. This sounds pretty high, and I think it could be setting up investors for bigger losses. Ask yourself whether you want to be aggressive or conservative — and not try to squeeze out every little dime from the investment at the risk of losing more than was made.
Last year, I dropped my selling PE, which is based on the forward earnings per share, to 16.5, based on the 40-year average.
Now it did cause me to sell out of some companies before they reached their top, but it also reduces risk because it is a more conservative average. One thing I would remind investors is the past 25 years includes the PEs from the tech boom, which was a very unusual time that we may not see again or at least for a long time. The Internet boom was unlike anything ever experienced in the history of the stock market.
So, investors beware: Don’t get too comfortable with high PEs from companies such as Facebook (Nasdaq: FB), Netflix (Nasdaq: NFLX), Tesla (Nasdaq: TSLA) and others that help artificially increase the average PE of the S&P 500.
Going forward in the housing market, we could see some changes over the next five to 10 years. Since the Great Recession, we saw many children return to their parents’ homes for economic reasons. Well, if you have Junior living with you or if you’re the one living with your parents, you know it’s getting old. That trend could be reversing and the kids may want place of their own. Maybe they can’t afford a big house, but maybe they could buy a smaller home, or even the need for more apartments could be on the horizon.
One company that may benefit from this change is Axiall Corp. (NYSE: AXLL), which gets 80 percent of its business domestically, so it is not in danger of a strengthening dollar.
A description of what this company does reads like a high school chemistry book and would probably put you to sleep, so let me say that its products are found in building materials.
Valuations over the past 12 months don’t look too bad when compared with the industry average. The best ratio is price to sales coming in at 0.70, compared with the industry average at 1.02. The worst is the price to tangible book value, which is 10.34 for the industry average.
But Axiall has goodwill and intangible assets that total nearly $2.9 billion. With equity of $2.5 billion, the company could be in trouble if some of those intangible assets or goodwill had to be written down.
If I were to buy this company, I would want to have a complete understanding of what this goodwill and intangible assets were and whether they could be written down in future years. The company apparently bought something in March 2013, so you don’t have to go that far back to discover what the purchase or purchases were.
Sales for the company were up 34.2 percent year over year — far greater than the industry average of 0.4 percent. Earnings per share is a different story. Axiall saw only a 0.72 percent increase in EPS, yet the industry shows a strange jump of 72.5 percent.
The current ratio looks good at 2.29 for the company — slightly higher than the industry average of 1.94. The debt to equity also favors the company at 52.6 versus the industry at 71.44. However, don’t forget about the intangible assets and goodwill if those are written down. They will increase your debt to equity because your equity will decline.
The efficiency of the company stood out as well with the receivable turnover and inventory turnover better than the industry average. The inventory turnover is twice that of the industry.
This stock peaked in March of last year at $64.96 and has declined 35 percent since then. Looking out to December 2014, the mean estimate of the EPS is $4.28, which is a nice increase from December 2013 EPS estimate of $3.64. With a current share price about $42 per share, the stock trades around 9.8 times forward earnings — not too bad in this market. The company also has a reasonable PEG ratio of 1.70.
If you think the trend in living arrangements could be changing over the next few years, maybe Axiall is a good buy for your portfolio, but don’t forget to check those intangible assets before you make your investment.
Have a question or a company you'd like me to take a look at? Email me at firstname.lastname@example.org.
Wilsey is president of Wilsey Asset Management and can be heard at 8 a.m. every Saturday on KFMB AM760. Information is provided by Reuters.