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Signs Of A Real Market Bottom

Posted on | June 16, 2011 | Comments Off

The following are some interesting characteristics of a market bottom.  Let’s walk through them, then make an educated guess on where we stand with regards to such a bottom currently in the stock market.

Compressed P/E Ratios

A market bottom will have compressed P/E ratios.  P/E ratios should be in the single digits, maybe 6-8 at a market bottom.  Not only are earnings usually down in a down market (a natural result of a tough economy) but the ratios themselves are compressed, this has a double effect on decreasing the stock price.

High Dividend Yields

Similarly, dividend yields will increase as share prices go down.  Now some stocks will cut dividends in a really ugly environment, but still, overall, yields should be much higher.  At a market bottom, you should be able to find plentiful stocks in the 4-7% dividend yield range.

Cash is King

At a market bottom, people will be of the opinion that cash is king.  They will be hoarding cash.  Ultimately, this cash is then deployed and fuels the leg up in stock prices.

IPOs Are Scarce

IPOs usually come in droves when the market has already had a big run higher.  The reason is that companies want to take advantage of hungry investors and get the most bang for the equity they are selling.  In a market bottom, IPOs will almost be nonexistent because the money they get for selling equity will be so low.  Remember, an IPO is nothing more than selling part of the company.  When will you want to sell a company?  When people are willing to pay more for it.

Today’s Market

Unfortunately, all of these signs are the opposite to today’s market.  You could make the argument that we are at or near a top in the market.  The IPOs are a very interesting sign especially the high profile tech IPOs like Pandora (P), Groupon (not yet), and LinkedIn (LNKD).

It is very difficult to find high yields in today’s market which is why we definitely warrant patience right now.  Too many people are chasing dividend growth stocks because they can’t find high dividend yield; therefore, these stocks have been pushed very high.  McDonald’s (MCD), one of the stocks in our dividend portfolio has been pushed very high this year.

Another interesting aspect of this discussion is the idea of pricing the market in gold. If you price the market in gold, we’ve been in a straight bear market since the peak in 2000.  You can read more about this and tracking the Dow in terms of gold here.

What to do?  Be patient and stick to your game.  Our game is high quality dividend stocks and buying in bulk at very attractive rates.  Those attractive rates will come in the future.  For now, we’re fine sitting tight and letting our dividends roll in and reinvest.

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