Don't buy right now

I'm a bit bewildered at how much equities have snapped back since I started this blog early last fall (2007).

My concern is that Benjamin Graham's "Margin of Safety" for the majority of the S & P 500 stocks in the USA and almost all of the TSX equities has now become negative.

The way you calculate it using Graham's method is very simple. You look up the rate of return for a 30 year treasury bond (4.375% today-- I just checked). Then calculate your earnings yield by inverting the P/E ratio of the equity of interest. For example the current P/E for the entire S&P 500 is about 22 today. 1/22 x 100 = 4.5%. The margin of safety is compared to the bond interest rate: 4.5- 4.375/4.5 x 100 = 2.7%. That's not much. Essentially your protection for future earnings dropping off below projections and maintaining your capital outlay for this stock is just under 3%. You better be darn sure that you're correct and the analysts are correct in their guessing game of future performance or else.... you're gonna lose money.

Now repeat this exercise for BBSI Barrett Business Services. P/E is 10 therefore there is 150% margin of error (or safety). This helps investors sleep better at night.

Think about this next time you buy a "hot" stock with a P/E of 100+.

Today Warren Buffett and George Soros both stated that they felt the credit crunch was far from over. Mr. Soros' opinion doesn't mean much to me as I consider him to be a day trader and I have a hard time following his economic reasoning. Mr. Buffett says that there will be secondary and tertiary after shocks which are likely to shake down the market sooner than later. In simple language: the market is likely to get cheaper as a whole than it is now, and soon.

After the predictable short term reaction of the market to these comments boils off, I would take the opportunity to sell weak positions (sitting at or above fair market value) and keep cash on hand for some possibly excellent buying opportunities over the next 6 months. I certainly wouldn't buy now unless the individual equity you are interested in already has a large MOS.

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