Ben Graham's market valuation

Goldsmith note: Porter's out for the day. He'll return on Monday. Until then, here's a brief Digest from yours truly.

In an effort to smooth out erratic earnings (from both business cycles and sentiment) and place a proper price-to-earnings ratio on a security, value legend Benjamin Graham divides price by the 10-year average earnings of a company. This measure is called P/E10. The average P/E10 for the S&P is 16.3. As you can see from the chart below, the current P/E10 is 21.8. The chart also shows any time the P/E10 reaches the low- to mid-20s (with the exception of the tech boom), the market tanks.

At 21.8, the market has entered the most expensive quintile, meaning it is more expensive now than it has been 80% of the time. SocGen analyst Dylan Grice points out that using the top quintile as a starting point, investors can expect a mere 1.7% annualized return over the next 10 years.

Bond King Bill Gross is a bit more optimistic. He believes the "new normal" return for stocks is 5% to 6%. But he's not focusing on equities. Instead, Gross believes it's time to focus on real estate if you want outsized returns... "Ultimately the riskier assets will be the less the risky assets," he said. "I wouldn't suggest moving into those particular sectors at the moment but ultimately risk and reward go together." Gross believes the bottom for real estate is in. We agree. But choose carefully. We think nonprime real estate will be dead money for years to come.

A belated kudos to Penny Stock Specialist editor Frank Curzio... This Monday, private-equity giant Cerberus Capital announced it would buy Frank's military contractor pick, DynCorp International. The price was $1.5 billion – a 50% premium to the previous day's closing price and 61% higher than the price where Frank's readers got in (only 45 days earlier). Some subscribers made even larger gains...

Thank you Frank for the outstanding work you do. I just made more then 600% on my investment in about two months on DCP. Keep it up. – Paid-up subscriber Ivan Salazar

Frank's latest recommendation is his favorite way to play the oil-and-gas boom. But it's not an exploration company. It's a "picks and shovels" play that will make huge profits as oil companies have a harder time finding deposits (a trend we're all certain is occurring). This stock is currently trading for around $5, and Frank expects it to double in the next year. To sign up for Penny Stock Specialist and get access to this report, click here...

New highs: Fairholme Fund (FAIRX), WisdomTree Japan (DFJ), ConocoPhillips (COP), Visa (V), Amerigas Partners (APU), Intel (INTC), Longleaf Partners (LLPFX), W.R. Berkley (WRB), Sequoia Fund (SEQUX), Prestige Brands (PBH), Brady Corp (BRC), Dana Holding (DAN), American Axle (AXL), Westport Innovations (WPRT), Northern Dynasty (NAK), Silver Wheaton (SLW), Rowan Drilling (RDC), Carbo Ceramics (CRR).

In today's mailbag, more praise for Porter's advice to the young and a letter from subscriber RL, who joined a Tea Party march in Manhattan yesterday (you don't want to miss this one)... What are your tax stories? Let us know... feedback@stansberryresearch.com.

"I have been reading Porter and Sjug since before (?) the Pirate days (see Oxford Club) and I have always enjoyed the info/advice/musings/etc. But yesterdays' (4/14) advice to Ian, from Porter, on what he wanted to be when he grows up... was nothing short of FANTASTIC!!! I copied it and will pass it on to any youngster who needs it (everybody!) whether they ask or not! THANKS for everything!!!" – Paid-up subscriber David Knisely

"I attended last night's tax day protest rally in Manhattan near the main post office. I went alone and brought one sign. The sign had two columns, the left one headed, 'Gov't Takes' and the right one headed 'U-Keep'. Under the headings I listed and totaled the projected income tax percentages to be paid by a New York City resident next year. The Gov't column also added sales tax since income must be spent. I used the top income tax rates (which kick in at a low level in regard to the cost of living in New York City). FICA was listed as 6.2% (I know it's capped at $106,000 currently but that could soon be uncapped; I did not include the employer portion of the payroll tax) and Medicare at 3.8% (new health care law). The totals were 69.825% for the government, 30.175% that the worker keeps.

"Of course this did not include many other taxes and fees we New Yorkers pay – real estate tax, parking tax, incorporated business tax surcharge, etc.

"Unremarkable as I thought my sign was (since it only included numbers and no commentary) I could not believe how bent out of shape certain passerby became when they read it. To be fair I received much positive attention too. But my detractors ranged from incredulous to unhinged. Mind this was near Penn Station so the vituperative comments were not from counter-protesters but generally those walking toward Chelsea and the West Village. Demographically the criticizers were white and under 35 years old, although one graybeard shouting at me, 'Those numbers are not true!', stands out.

"I did not seek to engage anyone in conversation nor provoke animosity. I answered all questions calmly. Unbelievers were informed that all rates came from Federal and State websites, and that I have paid and will pay these rates.

"Just to acquaint your readers with me, I am 50 years old and a retired leader from the business world and former Marine Corps officer. I serve in leadership positions in several non-profit corporations, including one school. You and Goldsmith may vouch for my authenticity.

"Porter please keep your analysis and commentaries coming. I am inspired by the moral courage you have shown in your publications." – Paid-up subscriber RL

Goldsmith comment: Well done, RL! Also, RL supplied us with the image from his sign below:

Regards,

Sean Goldsmith
Baltimore, Maryland
April 16, 2010