S&P 500 Back To Fair Value

May 21st, 2010 by hackel Leave a reply »

The 3.5% decline in the S&P has now brought the index to approximate fair value, given our expectation of 4% annual growth in free cash flow over the coming five years and a 8.1% cost of equity capital. The last time we wrote this was the case, the S&P rallied 15% over the coming 3 months.

Although the cost of capital has risen over the past month, the decline in valuations, to 17.8x FCF, has resulted in a fair valuation. Although many firms are reporting impressive growth in operating cash flow, we are finding much of this cash is to be consumed in newfound growth initiatives. We would avoid these entities, and would continue to concentrate on firms which have shown continual improvements in their cost structure.

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