KLE 47: It’s Payback Time!
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If you’ve downloaded my special SP500-Pricing-Calculator Spreadsheet then you may (or may not) have two ‘buy signals’ for the market; today, we’ll add the final one:
Step 3: Finding the Market’s Payback Time
If you invest $100 in a new calculator, and estimate that it would save you $10 a month in time and mistakes (compared to doing all your adding/subtracting on paper or in your head), then the calculator would have paid itself off in 10 months. That’s a ‘payback time’ of 10 months.
Wouldn’t it be great if you can do the same thing with stocks?
Well, you can for an individual stock (it’s just the earnings of the company, compared to the price of the stock, but we’ll cover this in some detail in the next Module), but not for the entire market (or, for the S&P500, which represents a big slice of the market).
At least, not until now …
Even though you can’t get your hands directly on the cash (earnings/profits) of any single stock, let alone all 500 companies / stocks that make up the S&P500, the price of the stock is directly related to those earnings.
So, by estimating just one more number – the return that you expect from the stock market – and adding it to my spreadsheet, you can easily find the time that it would take the price that you paid for the stock to be paid for by accumulated future earnings:
1. Enter the expected S&P500 earnings growth rate in the yellow cell (Column E); I use 11% as this is the long-term earnings from the S&P500. You can choose to use the current return if you prefer (use google and pick a period. Last 5 years? Last year? You can see the problem!); I simply like using the long-term average.
2. Now cast your eye over Column B of the spreadsheet; this represents the Accumulated Earnings Per Share of the S&P500 (add all the yearly profits of every company in the S&P 500, and divide that by the weighted total # shares issued; or, just use my spreadsheet!). The best thing is, this is all calculated for you … you don’t have to do a thing, except look in the grey column (Column C):
– When the number in the grey column > 1, then look at the row number, and
– The row number represents the Payback Time of the S&P500 in years
Example: In the diagram, below, the Payback Time is somewhere between 8 and 9 years:
If the Payback Time for the S&P500 is 10 years or less, then it’s a ‘buy’.
Otherwise, keep your money in The Bank.
But, what if you only get one or two ‘buy signals’? Or, what if some (or even all) of the buy signals are ‘line ball’ e.g. an RGV of close to one, or a Payback Time close to 10 years?
Well, that depends on whether you are a “glass is half full” (optimistic) or “half empty” (pessimistic) type of person! Your honest answer will tell you whether an RGV of 1.0 (or even 0.8 to 1.2) is a BUY or a SELL / NO BUY. Same with P/E’s of 13 to 17 and Payback times of 10 to 12, or thereabouts.
The next KLE will explain WHY you can buy outside the thresholds IF you are an optimist.
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Task 1: Calculate the Payback Time for the S&P500. Do NOT buy it yet!
