Valuation Series Vol. 2: Corporate Bond Yield PE Proxy

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There can be a good deal to gather from the spread on sound corporate bonds vs. a riskless treasury. Currently at 1.26%, with the treasury at 2.32% we find that the yield on these bonds is obviously 3.58. Now here is where the indicator comes in: If you flip the yield, you now have a sort of price/earnings ratio for corporate bonds. This is somewhat of a proxy for relative valuation to stocks.

When flipped, this P/E Ratio for corporate bonds becomes roughly 28. Based on this back-of -the-envelope calculation, we find another reason that stocks are not horribly valued It is obvious, though, that the chart below shows stocks disconnected to this ratio for reasonably long periods of time.

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Much like theory, stocks do have an intrinsic value, but rarely does it actually cross the street at exactly that point. As evidenced above, these two measurements share the same value, but for years at a time this may not be so. As Benjamin Graham said, markets are a voting machine in the short-term and a weighing machine in the long-term.

Sources: FRED, Bloomberg

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Valuation Series Vol.1 : Median P/E Ratio

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The Price to Earnings, or PE, ratio is used to guage how much investors are willing to pay for each dollar of earnings a company, or group of companies, earn. It’s easiest to think of this as a unit price at a grocery store. One fail-safe for using this metric to view a company before you impulsively buy, is that a company with negative earnings (losses), will not generate a ratio. It is usually best to stay away from these long-shots, at least in my eyes.

Using the median Price/Earnings ratio of a broad index like the Russel 1000 Index helps us to escape some of the noise off a straight average. For example, in a market-cap weighted index, the largest companies have the most pull on the calculation. This shows us what the middle-of-the-pack company is doing. My calculations are guilty of survivorship bias, as the pool of companies has shrunk over the years and the available data I have is not as extensive as I’d like. Either way, working with what we have, we find that, despite the new market highs and the duration of this trough to peak, the median company is just a tad above it’s average.

The abnormally large Cyclically-Adjusted-PE-Ratio, made famous by Robert Shiller, may be influenced a bit too much by the likes of FANG. It is important to keep in mind though, that there are many tools for generative a point of view, and this is just one of them.

Source: Bloomberg