It’s been another terrifying time for U.S. stock-market investors — the S&P 500 SPX, -0.08% suffered its worst first-half for any year since 1970. Where do we go from here?
Having lived through 1929’s Great Crash, John Burr Williams wrote his classic treatise, The Theory of Investment Value, arguing that the intrinsic, long-term value of a stock is the present value of the future cash an investor expects to receive, discounted by the investor’s “personal rate of interest.”
The total amount of cash flowing from a corporation to its shareholders consists of the dividends plus share repurchases. In recent years, corporate disbursements to shareholders have increasingly been in the form of repurchases—which makes sense because of their favorable tax treatment. The last input we need is the future rate of growth of S&P 500 dividends plus repurchases. Since 1998 , the annual growth rates have been about 6% for dividends and 10% for repurchases. For the sum, dividends plus buybacks, I am going to use the seemingly conservative value of 5%, which is a little lower than the long-run growth of U.S. GDP.
Warren Buffett explained it this way: “You have to have the knowledge to enable you to make a very general estimate about the value of the underlying business. But you do not cut it close. That is what Ben Graham meant by having a margin of safety. You don’t try to buy businesses worth $83 million for $80 million. You leave yourself an enormous margin. When you build a bridge, you insist it can carry 30,000 pounds, but you only drive 10,000 pound trucks across it.
This probability distribution is slightly skewed to the right with a mean of 5151.48 and a median of 4999.69. There is approximately a 4% probability that the intrinsic value of the S&P 500 is less than 3902.62, its value on July 7.
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