Are Stocks Overvalued?
I typically watch CNBC during my lunch hour. I like to catch the latest Halftime Report, since it often includes guests whose opinions I respect when it comes to the markets.
The big topic du jour is: Are stocks overvalued right now, and therefore is the market about to have another correction?
A number of commentators have recently pointed out how bullishness among investors has accelerated recently, which is a contrary indicator that could spell trouble ahead for stocks.
When bullish investor confidence gets too high, that’s bearish.
The Dow Jones Industrial Average notched another 1,000-point milestone, closing above 28,000 for the first time last week. This recent race to record highs in the Dow, S&P 500 and Nasdaq has more and more folks concerned that stocks have run too far too fast for their own good.
So let’s not speculate here. Instead, let’s take a look at the cold, hard historical data on stock valuations to find out if the market is too expensive.
The graph above charts the S&P 500 forward price-earnings (P/E) ratio, along with several other popular measures of market valuation in the box at upper right.
A P/E ratio is the ratio used for valuing a company that measures its current share price relative to its per share earnings (EPS).
Starting with P/E, you can see right away that stocks are trading at 16.82x earnings right now. That’s not much above the 25-year historical average of 16.22. Taking a closer look at the box, you can also see that price-to-book and the dividend yield of the S&P 500 are likewise just about “average” right now.
The only measure that looks somewhat elevated to me is price-to-cash flow, which is about 15% above average.
Still, that’s not wildly overvalued in my book.
Plus, if you look at the earnings yield spread (EY), or the difference between the current earnings yield for the S&P and corporate bond yields, stocks appear to be somewhat undervalued right now.
Bottom line: The answer to everyone’s big market question is no and no. Valuation alone is a terrible market timing indicator. That’s because stocks can, and often do, stay overvalued for a long time before leading to a correction.
And as the hard data above show, stocks don’t look all that overpriced to me right now.
Here’s to growing your wealth,