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Richard Pzena: Why Equities - Why Now
Posted by: gurufocus (IP Logged)
Date: May 10, 2010 08:49PM
We offer the following observations: - Equities in general are attractively valued, and the equity risk premium is wider than normal;
- Companies are well positioned to expand margins and sub-stantially increase profitability, having slashed operating costs and strengthened their balance sheets during the downturn; and
- Leading companies have positioned themselves to weather a wide range of economic scenarios, and require only modest top-line growth to generate meaningful profit improvement.
Why Equities - Why NowFirst we examine the relative attractiveness of equity investments versus fixed income alternatives from a high-level perspective. Figure 1 presents the risk premium investors have assigned to equities in the US market over the last 30 years. The current risk premium, defined as the expected return on equities less the risk free rate, is at a very attractive level: 5.9%, versus an average of 2.9% over the last 30 years. Other than the once-in-a-generation peak reached during the recent financial crisis, we have only seen this wide a premium four times in the last 30 years. Today, based on our dividend discount model, the expected return on equities is 9.7%, a substantial premium to 10-year treasury yields of 3.8% and yields on corporate debt of 4.6%.
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