Nancy B King

Now, I know why I have been feeling so unenthusiastic about stocks—other than we are in a major recession with no substantial sign of sustainable growth coming our way.

I’ve been working on a lecture about economic cycles and the return on stocks, bonds, and cash. Since I do not have access to the Ibbotson data, I’ve been digging around the Internet and found a great data table from Aswath Damdaran. Take a look at the chart I created from his data, particularly for the return on stocks from 2000-2009 —a minus 0.96%. That is like, “Oh, my gosh!” I know there have been ‘up times’, but the ‘down times’ seem to have left a more lasting impression on me.

Stocks were up 25.92% in 2009. However, stocks were down 36.58% in 2008. Maybe that is why the Downs make more of an impression on me than the Ups.

It’s going to be a while before the current housing problems work their way through the economic system. The following chart and comments are from  Chart-of-the-Day.

Housing continues to be a serious problem for the U.S. economy with a tremendous amount of unsold overhang remaining in the system.

This means that more than 7 million homes remain weighing down the market, due to bank’s having repossessed them or the loans being in delinquency.

It’s interesting to note, per this chart from Whitney Tilson’s T2 Partners, this does not include new defaults, which are around 300,000 per month.

Read more: http://www.businessinsider.com/chart-of-the-day-housing-crisis-2010-5?utm_source=Triggermail&utm_medium=email&utm_campaign=CS_COTD_051010#ixzz0nphuwHIX

With the market down and my being stopped out of two stocks, what else was there to do but dig around the internet and see what was new.

I found the following: Aether Ios Limited (a wholly owned subsidiary of Intercontinental Exchange Inc–NYSe: ICE) ) acquired 53.5 percent of the Chicago Climate Exchange. Richard Sandor, Executive chairman of Climate Exchange, will receive $606M for his 17 percent ownership of the Exchange.

However, it is the-behind-the-scenes info that intrigued me. What is the Climate Exchange? Who is Richard Sandor?

The Initial Idea and the Start-Up Plan for the Chicago Climate Exchange

The story begins in 2000. Richard Sandor worked through the Joyce Foundation with the help of his good friend Barak Obama, a board member, to obtain $1.1 million in grants to develop, pilot, and launch his idea of a private exchange to trade carbon credits. Obama guided the money to make sure Richard Sandor’s idea got off the ground. The grant monies were funneled through the Kellogg Graduate School of Management at Northwestern University where Sandor was a research professor and taught a class in environmental finance.

The Climate Exchange: A Forward-Thinking Idea

Carbon and other types of emission credits were already traded in Europe. Before too long, some type of emissions cap and credit trade legislation would pass in the United States which would create the need for an exchange and the technology to trade the credits. Carbon credits are, allegedly, a way to curb industry air pollution. With “Cap and Trade” the government determines how much carbon it will allow industries to emit. Industries that emit more than the fixed amount and use all their credits may buy additional credits from industries that do not use all their credits. The buying and selling of these credits takes place on an exchange. The exchange that trades carbon credits will become a $10 trillion business when the U. S. government passes the Cap and Trade bill. The Chicago Climate Exchange was born.

The Technology Necessary to Operate the Climate Exchange

The next step in getting the Chicago Climate Exchange up and running was to acquire the necessary technology to initiate, track, and complete the trades. Carlton Bartells at CO2E.com had devised the technology for trading carbon credits. He had filed for the patent. The paper work was just sitting in the patent office. Nothing was happening. During this time, Carlton Bartells was killed on 9/11. After his death, his wife decided to sell the patent—the patent that was stuck in the patent pending department. The patent sale came to the attention of Franklin Raines, who at the time was running Fannie Mae.

Franklin Raines or rather Fannie Mae purchased the technology even before the patent had been approved. Those at Fannie Mae wondered why an entity whose business was guaranteeing housing loans and making housing affordable for all was buying technology to trade carbon credits. Fortunately, for Raines and Fannie Mae the patent was immediately approved following the 2006 Democrat win.

Big Investors to Make the Chicago Climate Exchange a Major Player

The Chicago Climate Exchange had its start-up company in place and had the needed technology to trade carbon credits. Now it needed large investors get the Exchange off the ground and into a highly competitive position. One of the first large investors was Generation Investment Management (GIM). GIM is an investment company located in Great Britain. Al Gore is its co-founder along with three Goldman Sachs men, David Blood, Mark Ferguson, and Peter Harrison. (a snarky note: Al Gore seems to be an astute businessman while protecting the earth. Nothing like a little capitalism to go with altruistic environmentalism.) After the 2006 election Goldman Sachs bought 10 percent of the Chicago Climate Exchange. Currently, the largest share holder (29 percent) is Invesco Assets Management. ICE’s Atlanta-based subsidiary is a small investor at 4.8 percent, or was before ICE acquired controlling interest in the Exchange on Friday.

Customers for The Chicago Climate Exchange

The Chicago Climate Exchange began voluntary, legally binding carbon credit trading in 2003. More than 350 companies and entities, such as Ford, DuPont, Motorola, the cities of Oakland and Chicago, the National Farmers Union, and the Iowa Farm Bureau, trade emission credits on the CCX.

To be truly successful and attain the projected profit of $10 trillion a year, trading carbon and other emission credits needs to become mandatory. Hence, they are waiting for the Cap and Trade legislature to pass.

Thanks to IBD (Investors Business Daily) I can see—visually and understand—that the S&P 500 ETF performed better year-to-date than other benchmark ETFs around the world. I wasn’t thrilled by the -0.05% gain/loss until I looked at France and Germany. I’ll take the U.S.

The price/earnings ratio (P/E, PE) by itself has limited use. It merely indicates investors’ demand for the stock. The greater the demand, the higher the P/E because the stock’s price has been driven up by investor buying. Think of the P/E as a popularity indicator.

How to use P/E

By comparing a stock’s P/E with other P/Es, investors can determine whether a stock is over-, under-, or fairly priced. Compare a stock’s P/E with the following:

1. the P/E of the S&P 500 Index

2. the P/E of the company’s industry

3. the P/Es of the company’s close competitors

4. the stock’s 10-year average P/E

Comparing P/Es

1. Compare the Stock’s P/E with the P/E of the S&P 500 Index to determine whether the stock is fairly priced compared with the overall market. Currently, Home Depot’s (HD) P/E is 20.85 and the P/E of the market—the S&P 500 Index P/E—is 19.84. At this time, Home Depot’s stock is fairly priced (within 1½ to 2 points) compared with the overall market.

Home Depot’s P/E: http://finance.yahoo.com/q?s=HD

S&P 500 Index P/E: http://www.multpl.com/

2. Compare the Stock’s P/E with the P/E of Its Industry. P/Es are industry specific. Each industry has its own average P/E. Industries move in and out of favor with investors depending on the economy.

Begin by determining whether the industry is currently in or out of favor with investors. Compare the industry’s P/E with the market’s P/E. The Home Improvement Stores industry has a P/E of 19.80. This is in line with the overall market. On the other hand, the Broadcasting-TV industry (P/E of 0.60) and the Steel and Iron industry (P/E of 12.20) are out of favor. At this time, few investors are buying broadcasting-TV and steel and iron stocks because they feel companies in these industries will have difficulty maintaining their profitability in the current economy.

Industry P/E: http://biz.yahoo.com/p/industries.html For Home Depot’s industry P/E, scroll down to Home Improvement Stores.

Next, compare the stock’s P/E with its industry’s P/E. Home Depot has a P/E of 20.85 and the Home Improvement Stores industry has a P/E of 19.80. Home Depot’s stock is fairly priced compared with its industry. Investors feel that Home Depot will be able to grow its earning as well as the companies in the industry as a whole.

3. Compare the Stock’s P/E with the P/Es of Its Close Competitors. Home Depot has a P/E of 20.85, Lowe’s a P/E of 18.86, and Lumber Liquidators a P/E of 24.27. Investors expect Lumber Liquidators’ earnings to grow faster than either Home Depot’s or Lowe’s earnings. Home Depot is fairly priced when compared with Lowe’s and slightly underpriced compared with Lumber Liquidators.

Competitor P/Es: http://biz.yahoo.com/p/industries.html Scroll down and click on Home Improvement Stores to find a list of Home Depot’s competitors. (see the above Industry P/E insert)

4. Compare the Stock’s Current PE with the Stock’s 10-Year Average P/E. This comparison tells you whether the stock is fairly priced compared with the company’s past performance. Home Depot’s P/E over the past 10 years has ranged from a high or 42.9 to a low of  10.7. Its 10-year average P/E is 21.19. Home Depot’s stock is fairly priced compared with its 10-year performance—20.85 vs. 21.19.

Stock’s  10-Year Historical P/Es: http://quicktake.morningstar.com/StockNet/Valuation10.aspx?Country=USA&Symbol=HD You will need to calculate the 10-year average P/E.

Is Home Depot’s Stock Overpriced

Currently, Home Depot’s stock is fairly priced when compared with the P/E of the S&P 500—the market (20.85 vs. 19.84), fairly priced when compared with its industry P/E (20.85 vs. 19.80), fairly priced when compared with one of its competitors’ P/Es and slightly underpriced when compared with the other’s P/E (20.85 vs. 18.86 and 24.27), and fairly priced when compared with its 10-year average P/E (20.85 vs. 21.19). Therefore, based on P/E comparisons, Home Depot’s stock is fairly priced.

In Conclusion

To determine whether a stock is over-, under-, or fairly priced, compare the stock’s P/E with the P/E of the market and the industry, the P/Es of its major competitors, and with its own 10-year average P/E.

Try It

Determine whether a stock of your choice or one of the following companies is fairly priced: Nordstrom’s (JWN), Alaska Airlines (ALK), or Johnson and Johnson (JNJ).

Step-by-Step

1. Determine the stock’s P/E by going to http://finance.yahoo.com/q?s=HD. Enter your stock’s ticker symbol.

• The stock’s P/E is ___________.

2. Determine the P/E of the S&P 500 Index (the overall market) by going to http://www.multpl.com/.

• Compared with the market, the stock is over-, under-, or fairly priced: ________

3. Determine the P/E of the company’s industry by going to http://biz.yahoo.com/p/industries.html.

• Compared with the company’s  industry, the stock is over-, under-, or fairly priced: __________________

4. Determine the P/E of the company’s competitors by going to http://biz.yahoo.com/p/industries.html and clicking on the company’s industry to see the company’s competitors and their P/Es.

• Compared with the company’s closest competitors, the stock is over-, under-, or fairly priced: __________________

5. Determine the stock’s 10-year average P/E by going to http://quicktake.morningstar.com/StockNet/Valuation10.aspx?Country=USA&Symbol=HD and entering your stock’s symbol. Calculate your stock’s 10-year average P/E by adding the 10 values and dividing by 10.

• Compared with the company’s 10-year average P/E, the stock is over-, under-, or fairly priced: _______________

Your Conclusion: Considering the above P/E comparisons, the stock is over-, under-, or fairly priced: ____________.

Looking Ahead

In the next article I will discuss answers to the following two questions: Why do some stocks have P/Es that are 30, 40, or more points above the market P/E? If a stock’s P/E is 8 or more points below the market’s P/E, does the low P/E indicate the stock is a true bargain, or does is signify the company is unhealthy?

The DOW down 213.27 points today. Citigroup and Bank of America down 6% and JPMorgan down 7%.

Fortunately, I’m mostly out of the Market right now—sold before the end of the year and have been busy  getting ready to teach my Mutual Funds class.

On the other hand, the stock (VSEC) that  I purchased  on Tuesday to activate my Stock Market Game portfolio is mostly intact.

The story began with a small lake of money that became an enormous reservoir looking for a place to flow. In 2000 the lake held 36 trillion dollars. By  2006 the lake had become a reservoir containing 70 trillion dollars looking for a place to flow.

The pool of money comes from savers around the world. It comes from you and me, from the people and companies in India and China who have been manufacturing the goods we buy—they made a lot of money, banked it, and saved it. It comes from all the oil producing countries, from individuals in France, Brazil, Russia, Ireland, England, South Africa, etc. It comes from premiums insurance companies charge and save until they need them for a catastrophe, from pension funds that are waiting for people to retire and start drawing their retirement checks, and from central banks that save for all the reasons they save.

In 2010 this is money  looking for a place to be invested. True some of it was lost in the market, but others have made money in the current market. It is out there looking for an investment vehicle that will provide a return on the investment. New vehicles, new versions of Mortgaged Backed Securities, will be invented.

Read Clusterstock’s updated explanation of this phenomenon in the commentary on the above graph: It’s Going to be Brutal Putting the Banking Genie Back in the Bottle.

The Stock Market Game (SMG) is open for teacher and adult registration and for student investing. I’ve been doing a lot of  SMG marketing to teachers the last  few days. It seems to be paying off a bit. You are welcome to join us.

I have been watching football today and picking some stocks for my portfolio (SMG). I hope my stock picks are more successful than my team picks have been today.  However, I can’t even find my Happy Bull Market graphic–that has to be a bad sign.