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When Math Mattered

December 3, 2019

Good Afternoon:


I hope you had a wonderful Thanksgiving holiday.  


The financial markets have changed tremendously since my industry entry in the mid 1990's.  While access to information has improved 100x, understanding of valuation and risk has decreased in equal measure.


The Price to earnings multiple is a method of evaluating the relative price of a particular stock, or the broad stock market.  The inverse, its earnings yield (earnings divided by price) is a method for comparison to other investment alternatives.  


For example, the current trailing P/E for the S&P 500 is 23x.  Net, net investors are paying 23 Years of total earnings for the broad stock market.  On an earnings yield basis it would be 1 / 23 = 4.35%. 

The lower the earnings yield the higher multiple of earnings folks are willing to pay. 


Long term P/E multiples are generally in the 15x-17x range.   We have spoken frequently regarding the Federal Reserves action to "stimulate", i.e. inflate asset prices.  My ultimate concern is that the Fed has effectively broken most all markets (bond and stock) by not providing a fair, risk free return on capital from which to base risk decisions.


As rates are pushed lower and lower (by the Fed, or Trump Tweets!), the greater the distortion.  It seems as though everything has become a Reality Show.  Retirees are essentially being forced to take more and more risk, or cut their standard of living.


As a risk averse manager of assets, we do not like this "choice".  While there are differences of opinion, math ultimately matters.  


The attached Forbes article does a fine job at illustrating how investors willingness to pay more and more for stocks is being driven by assuming more risk (higher P/E multiple and lower earnings yield), not underlying earnings growth.


Fear not, Forest Capital is built around risk adjusted returns, and our ethos demands that safety of principal is paramount. 


Risk averse securities have had tremendous returns in 2019 and we are grateful.  


Coming into the Fall we accelerated purchases of higher yielding positions with solid underlying credit quality.  We will cling to these yields as long as they exists.
Net, net, we want to own durable and dependable cash flows. 


I hope you enjoy the article:











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Julien B. Booth

Principal & Portfolio Manager


Dana Christner

Operations Manager



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Charlotte, NC 28227

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