Finance: What Dickens can teach us about investing | Business 380

?A Christmas Carol? by Charles Dickens gives some insight into the author?s childhood when he was forced to work in a blacking (boot polish) factory during the Industrial Revolution of the 1800s because of his family falling on hard financial times.

The character of Scrooge seems to depict Dickens? love and disdain for his own father as the character transforms from a reclusive, greedy businessman into a generous benefactor to the poor, and particularly to the family of Bob Cratchit, his harshly treated and underpaid clerk.

This Christmas favorite also has its critics claiming it is an indictment on 18th century capitalism. Hopefully business has learned to be a bit more compassionate to its work force over the last 170 years.

Returning to today, the current unemployment percentage rate registers into the high single digits. Economists view each worker also as a consumer and an unemployed worker as consuming less.

Doug Rideout

High unemployment therefore leads to the forecast that aggregate consumption will be weak in such times.

In other words, the Cratchits of the world have less to spend and the Scrooges will see their revenues drop. The economy goes into recession, and everyone lose

But if we change the recession scenario to a slow-growth scenario, business revenues can remain steady or perhaps slightly increase. From an accountant?s view, the unrepentant Scrooge would be delighted to contain labor costs, given a steady stream of revenue, particularly if he also could improve productivity.

Despite all of us rooting for the Cratchits, the hard reality is that business profit margins improve when labor is in a weak bargaining position. The good corporate profit reports of the past few quarters bear out this fact and may influence the dour economists to boost business earnings expectations, if indeed we avoid recession.

Theoretically stocks trade as a multiple of corporate earnings. For the past

10 years, an investor could question that theory as the price/earnings multiple has fallen to the low teens from the high teens in the 1990s.

The stock market has been a challenging place in which to invest. The S&P 500 Index has averaged a mere 1 percent annual return, including dividends since 1999.

Sovereign debt problems in Europe currently head the decade?s problem list that includes domestic government budget battles, subprime housing debt, a real estate bubble, an Internet bubble, corporate accounting scandals, terrorist attacks, a few wars and even a few months in 2000 when we questioned a presidential election.

However, it?s still best for investors to stay balanced in their portfolios, holding 20 percent or more in stocks because of the historical upward climb of corporate profits.

(Click on the chart to enlarge it.)

Granted, those corporate profits can be volatile as they rise and fall with business cycles ? a fact easily noted in the accompanying chart of earnings obtained from Standard & Poor?s website. (I prefer using ?operating earnings? as opposed to ?reported earnings? to reduce the volatile nature of extraordinary items.)

The current 2011 estimate is 97.45. Investors often refer to these numbers as dollars per share of the Index, such as $97.45 per share of the S&P 500.

In a way, this helps one understand the purpose of the number, but actually it is an indexed number that can be compared to previous numbers to help identify trends. For example, the 1988 operating earnings number registered 24.12 ? one-fourth of the 2011 estimate.

It is no wonder that the S&P 500 also is up roughly four times in that 23-year time period. During the past 11 years, earnings started at 56.13 in 2000 ? a cyclical peak ? compared with the 2011 estimate of 97.45.

This translates to a 5 percent annual growth rate ? which is weak in comparison to the 1990s? rate of 9.5 percent ? but the market has more than discounted this fact by not rising the last 10 years.

As earnings rise and stock prices languish, price/earnings ratios have been compressing like a coiled spring since 2000.

If collectively we Cratchits can afford to spend enough to avoid an economic recession next year and side step a cataclysmic event such as the European debt crisis, corporations should be able to attain S&P?s estimated earnings of 107.68, a 10.5 percent increase.

A very logical expectation would be for a commensurate increase in the stock market ? otherwise the price/earnings spring just becomes more compressed and valuations are even more attractive.

Stocks have nearly doubled bond returns dating back to 1927, despite badly underperforming this decade. If corporate profits continue to advance as they have historically, it will eventually resonate with investors and stock prices will rise.

The textbook investment approach of a balanced portfolio of stocks and bonds remains one of the best strategies for investors, when stocks advance while the bond portion protects against the unforeseen shocks that can disrupt our best-laid plans for the markets yet to come.

Source: http://business380.com/2011/12/25/finance-what-dickens-can-teach-us-about-investing/

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