While this isn’t always an ironclad rule, it is a general guideline that should give the investor pause. Personally, one of the things we’ve done at my company to give us an idea of the relative attractiveness of our various positions is to build a database that compares the earnings yield (remember, that’s the inverse of the price-to-earnings ratio) to the long-term Treasury bond yield. Historically, if the spread continues to contract and stands at all-time lows, stocks aren’t a good buy. This cold, calculated method for viewing stocks as “equity bonds” has given us, we feel, a definite competitive edge and helped our returns trounce the market.
Of course, whether you are in the depths of a depression or the height of a bubble, there are always opportunities somewhere. One favorite example of this phenomenon in the financial press is that Berkshire Hathaway’s Class B shares hit a low of $1,500 in March of 2000 at the same time the NASDAQ, driven by Internet stocks, hit its high. Years later, the latter has collapsed while the former has grown to $3,660+ per share. Keep doing your research, stick with companies and industries you know and understand, and manage your affairs conservatively. Give it enough time, and the sheer power of compounding will do the heavy lifting.
