These days, there is certainly plenty of speculation about “when things will return to normal.” These kinds of concerns are nothing new. Just as we worry about defining and seeking “normal” today, so too did John Templeton’s clients worry about what was “normal” for the markets five decades ago. Repeated inquiries prompted him to circulate the following confidential memo to his clients in May of 1954. This is will be part one of a two part series.

The economic theory developed by Templeton, Dobbrow & Vance, Inc. for calculating the normal level of stock prices is simple. There are only three elements:

  1. Stock prices would be normal if they bore the same relationship to current earnings as has been customary for the latest 20 years.
  2. Stock prices would be normal if they bore the same relationship to the current cost of replacing the assets of the corporations as has been customary in the latest 20 years.
  3. When, because of changes in tax laws or changes in the money supply, high-grade preferred stocks sell lower in relation to dividends than has been customary in the latest 20 years, then it should be normal for common stocks to sell lower in relation to earnings; and vice versa.

Although the theory is simple, the actual calculation involves many thousands of figures. We take care to define accurately each word used in the principles above; and then the arithmetic is worked out on the basis of a large sample of representative stocks.