Value = [10yr-AVG.-IA-EPS] x (8.5 + 2 x G) x (4.4 / Aaa)

Determining Intrinsic Value S&P 500

Current Fair Value 1157 to 1057

Market Overvalued 81% to 98%

Over 53 years ago in his 1962 edition of Security Analysis, Benjamin Graham developed a stock valuation model based upon a few market and firm-related variables; I've simply adjusted this formula to determine the S&P 500 intrinsic value.  Wise old Ben observed many common stocks, his attempt is to determine the average stock price to recent earnings plus expected earnings growth.  Higher the current earnings and higher the expected earnings growth, greater the intrinsic value. The goal is to determine the proper PE multiple (similar to PE10) and ultimately the fair value for a stock or in this case the S&P 500.

Value =[10yr-AVG.-IA EPS] x (8.5 + 2 x G) x (4.4 / Aaa)

Where: Value = Estimated Value of S&P 500

• 10yr-IA -EPS = 10 years average inflation adjusted earnings per share. Multpl.com
• G = 10 year real average expected annual earnings growth
• Aaa = Moody's Seasoned Aaa Corporate bond yield (St. Louis Fed) 
• (8.5 + 2*G) x (4.4 / Aaa) = Earnings multiplier

The Growth Rate Controversy 

The growth rate is the most controversial of all numbers just watch the financial channels talking heads on T.V.  Many will throw out numbers that are so absurd to the test the level of mental competency or a sales pitch for the naive.  Plus the U.S. has an unsustainable profit margins that either will be reduced by competition or government edict as we shift from pro business to pro labor policies.  Another factor that pushes GDP growth and ultimately corporate growth as well has been our fertility rate. That has been dancing on a head of a pin between non growth or below replacement since 1973.  If it were not for emigration our population momentum would have stalled years ago along with that portion of GDP growth.

I've gone to two sources for an average growth rate for corporate earnings.  Jason Zweig who wrote his commentary portion of Benjamin Graham book The Intelligent Investor (soft cover page 85) stated that real average earnings growth between 1.5% to 2.0%.  William J. Bernstein book Rational Expectation (soft cover page 160) states that corporate real earnings per share growth rate has average 1.0% since 1871.  The lower number is derived by the dilution of stock offerings (despite their buybacks) for empire building and stock options of many CEO's.

And the Band Played On...1.0% to 1.5%

The solution is a fair value trading band for fair value.  To give an investor a sense of how far above, within, or below fair market in order to adjust one's asset allocation to the risk level of the market.

DYI