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Margin of Safety!

Central Concept of Investment for the purchase of Common Stocks.

"The danger to investors lies in concentrating their purchases in the upper levels of the market..."

Stocks compared to bonds:

Earnings Yield Coverage Ratio - [EYC Ratio]

EYC Ratio = [ (1/PE10) x 100] x 1.1] / Bond Rate

1.75 plus: Safe for large lump sums & DCA

1.30 plus: Safe for DCA

1.29 or less: Mid-Point - Hold stocks and purchase bonds.

1.00 or less: Sell stocks - rebalance portfolio - Re-think stock/bond allocation.

Current EYC Ratio: 1.00

As of 2-1-17
Updated Monthly

PE10 as report by Multpl.com

Bond Rate is the rate as reported by

Vanguard Long-Term Investment-Grade Fund Investor Shares (VWESX)

DCA is Dollar Cost Averaging.
Lump Sum any amount greater than yearly salary.

PE10  .........28.24
Bond Rate...3.89%

Over a ten-year period the typical excess of stock earnings power over bond interest may aggregate 4/3 of the price paid. This figure is sufficient to provide a very real margin of safety--which, under favorable conditions, will prevent or minimize a loss......If the purchases are made at the average level of the market over a span of years, the prices paid should carry with them assurance of an adequate margin of safety.  The danger to investors lies in concentrating their purchases in the upper levels of the market.....

Common Sense Investing:
The Papers of Benjamin Graham
Benjamin Graham

% Allocation Formula

2-1-17
Updated Monthly

% Allocation = 100 – [100 x (Current PE10 – Avg. PE10 / 2)]  /  (Avg.PE10 x 2 – Avg. PE10 / 2)

Current PE10.....28.24

Avg. PE10.........16.72

% Stock Allocation 21% 

Logic behind this approach:

--As the stock market becomes more expensive, a conservative investor's stock allocation should go down. The rationale recognizes the reduced expected future returns for stocks, and the increasing risk. 

--The formula acknowledges the increased likelihood of the market falling from current levels based on historical valuation levels and regression to the median, rather than from volatility. Many agree this is the key to value investing.  

Please note there is controversy regarding the divisor (Avg. PE10).  The average since 1881 as reported by Multpl.com is 16.70.  However, Larry Swedroe and others believe that using a revised Shiller P/E mean of 19.6 , the number since 1960 ( a 53-year period), reflects more modern accounting procedures.

DYI adheres to the long view where over time the legacy (prior 1959) values will be absorbed into the average.  Also it can be said with just as much vigor the last 20 years corporate America has been noted for accounting irregularities.  So....If you use the higher or lower number, or average them, you will be within the guide posts of value.      

  

DYI

Secular Market Top - Since January 2000

+  72.8% Dow       

+208.7% Transports 

+136.0% Utilities

+55.1%  S&P 500

+38.0%  Nasdaq

+52.9%  30yr Treasury Bond

+317.3% Gold

+106.3% Oil
  +59.7% Swiss Franc's

    

From High to Low

+317.3% Gold

+208.7% Transports

+136.0% Utilities

+106.3% Oil
+  72.8% Dow

+  59.7% Swiss Franc's 

+  52.9% 30yr Treasury Bond  
+  55.1% S&P 500 

+  38.0% Nasdaq

December 1999 Shiller PE10 was 44.19                 2-1-17 is 28.24

August 2000 S&P 500 dividend yield was 1.11%  2-1-17 is 2.01%

It is easily seen that in the year 2000 the Nasdaq was horribly overvalued and gold was on the give away table, such lopsided returns 17 years later!

Also of interest the stodgy 30 year Treasury bond has outperformed the S&P 500 and Nasdaq since the year 2000.  The modern portfolio crowd back in the year 2000 would find this a very low probability outcome.  Value player's, due to extreme valuations, would have recognized this as the most likely outcome (close to a no-brainer!).