Legendary value investor Bill Nygren knows when stocks are cheap. That’s why he thinks now is a great time to buy. Is he right?
“We think stocks are really cheap if you believe, as we do, that the economy is going to eventually recover, as will the P/E multiples,” he said. He draws the distinction between stocks that fall because they’re no damn good and those that fall because of one-time circumstances. Like the current coronavirus-shaken market.
As investors consider which equities to buy, they must make an important distinction between one-time occurrences for a company and changes to long-term earnings estimates, Nygren said. “Long-term changes, then you have to think about applying a P/E multiple to those changes,” he said.
“If you’re just talking about something that’s a one-time hit, then obviously the multiplier on that is just one,” Nygren told CNBC.
Certainly, Nygren is onto something. The price-earnings (P/E) ratio for the S&P 500 finished Thursday’s session at 19.8, a lot lower than the 25 level of January, after an epic bull run. And the Thursday finish came after a recovery—at least for the moment—of the market, crowned by yesterday’s 6.2% rise. The enormous $2 trillion aid package making its way through Washington gave investors heart.
Some Wall Street pundits are wondering whether this past week’s seeming resurgence is merely what’s whimsically called “a dead cat bounce.” In other words, a brief increase before another painful slide. Some say short covering is a factor. That is, investors who bet on a continued market tumble suddenly had to buy back stock they borrowed for their wager and return it.
Still, it’s remarkable that the lowering of the once swollen P/E has coincided with the dip of another, more long-term valuation metric. That would be the cyclically adjusted price-to-earnings ratio, commonly known as CAPE, the brainchild of Yale economist Robert Shiller. This tracks data 10 years back and adjusts for inflation, to give a better reading of the market’s valuation.
For some time, the CAPE has stood above 30. But only recently has it trended down again. In other words, the impact of the virus on stocks has been so profound that it has shifted around the market’s basic gravity. And absent a miracle cure for the disease tomorrow, why should that downward dynamic suddenly vanish?
Indeed, the current market hop still leaves the index far below its Feb. 19 peak. It sits at 22% below that high mark, still in bear territory.
Nygren’s Oakmark Select Investor mutual fund has taken a beating from the current downturn, off 33%, worse than the S&P 500. Not helping is his strong allocation to financial services stocks, which comprise a third of the portfolio.
The fund also got torched in the horrible year of 2018, coming in with losses worse than the market. That said, Nygren, who is a partner at Harris Associates, which runs Oakmark funds, has a very good long-term record.
“So we think there are a lot of attractive values if you believe the economy is eventually going to get better,” he said.