The historical analyses of stocks for valuation purposes are contingent upon relevant comparisons, that is comparing apples with apples. Surprisingly, that’s something missing in valuation studies, which typically compare today’s apples with apples picked years ago. In effect, what they are comparing is apples with oranges. Conclusions drawn by comparing current stocks or earnings with those of other time periods tend to be skewed, depending on when the analyses began.
Many valuations were skewed in 1999, for example, a period of bubble valuations. While there were some small companies with attractive valuations, there were many more with sky-high valuations that were worthless.
Different start dates result in dramatically different assumptions. Most historical analyses of stocks begin back in 1926, the year Standard & Poor’s launched the 90-stock composite price index, later expanded to include 500 of the largest US companies (large caps) in 1957. Using 1926 as the start date, small-cap stocks—represented by the Ibbotson Small Company Stock index from 1926–1978 and the Russell 2000 index from 1979–2022—would appear to have outperformed large caps by roughly 2% (12% to 10%). But that analysis is distorted by the fact that the Ibbotson index, initially represented by just a few companies, got off to a huge lead over large caps during the first decade. Starting an analysis at a different point in time would provide a markedly different result.
Think of a major league pitcher with an ERA of 3.50 at year’s end, a statistic comprised of perhaps 30 or 35 starts. Like small-cap stocks, the hurler may have gotten off to a rousing start in April and May, compiling an ERA of 1.50 during that period, but as the season progressed, his ERA steadily rose and by year’s end, he was getting hit to the tune of an ERA near 6. Depending on what month an analysis of his year began, the conclusion of what kind of a year he had would vary greatly. Just ask his agent, arguing with management for an annual raise after his client was bounced around like a ping pong ball the final few months.
The bottom line
Those who ignore—or are unable—to conduct bottom-up financial analysis will continue to mistakenly base their valuation assertions on dated charts and calendars, a fool’s game. Their flawed analysis is arguably the number one cause of investor failure among the so-called “informed” crowd. It’s always the “strategists” who are “historians.”
Krilogy Financial, LLC (Krilogy) is a Securities and Exchange Commission (“SEC”) Registered Investment Advisor. Registration with the SEC should not be considered an express or implied approval of Krilogy by the SEC. Krilogy does not provide tax and legal advice. All expressions of opinion are subject to change. This information is distributed for educational purposes only, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, products, or services. Investments involve risk and unless otherwise stated, are not guaranteed. Investors should understand the risks involved of owning investments, including interest rate risk, credit risk and market risk. Be sure to first consult with a qualified financial advisor and/or tax professional before implementing any strategies discussed herein.