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Kass: Fair Market Value Update

Whether one is gazing at charts or incorporating fundamentally based discount models, all too often technical and fundamental analysts proclaim precision of market forecast. Frankly, I view those pronouncements as laughable.

There is no special sauce, fractal or system to beat the market and to forecast its future with consistent accuracy -- if there was, Steve Cohen, George Soros or Paul Tudor Jones would have purchased the recipe.

I use this morning's exercise as a guide to portfolio management. Again, it is certainly not meant to be an exercise in precision, but I have found this calculation, over time, to be a generally good discipline that keeps me honest.

The Market Is Moderately Overvalued

The line separating investment and speculation, which is never bright and clear, becomes blurred still further when most market participants have recently enjoyed triumphs. Nothing sedates rationality like large doses of effortless money. After a heady experience of that kind, normally sensible people drift into behavior akin to that of Cinderella at the ball. They know that overstaying the festivities -- that is, continuing to speculate in companies that have gigantic valuations relative to the cash they are likely to generate in the future -- will eventually bring on pumpkins and mice. But they nevertheless hate to miss a single minute of what is one helluva party. Therefore, the giddy participants all plan to leave just seconds before midnight. There's a problem, though: They are dancing in a room in which the clocks have no hands.

-- Warren Buffet's letter to Berkshire Hathaway shareholders, 2000

I continue to see the stock market as being moderately overvalued -- the higher we go from here, the line between speculation and investment seems likely to be increasingly blurred.

In the past, I have suggested that in a 5% overvalued market, a conservative investor should not be more than 50% long -- and I still stand behind that.

So, if I believe (as I currently do) that the market is slightly more than 5% overvalued, why have any investments in equities?

The answer is obvious.

At any given time (regardless of where the market is selling), individual stocks are overvalued and undervalued. This is particularly true today since there is so much uncertainty in fiscal (and monetary) policy, in political/economic outcomes and with regard to business and consumer reaction to policy.

Don't take my word for the fair market value calculation. Again, I strongly encourage you to input your own earnings/economic/multiple expectations and create your own fair market value calculation.

This allows investors and traders to pick sides on the issues and make their bets a bit more intelligently, particularly on the broader market.

I hope you find this exercise to be helpful as a guideline.

This column originally appeared on Real Money Pro at 8:24 a.m. EDT on Oct. 21.
At the time of publication, Kass and/or his funds were short SPY and BRK.B, although holdings can change at any time.

Doug Kass is the president of Seabreeze Partners Management Inc. Under no circumstances does this information represent a recommendation to buy, sell or hold any security.

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