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While we wait on some big tech earnings (MSFT, META, TSLA, and AAPL all report this week) I thought it would be a good idea to continue with our review of the stock market's macro environment. So today, we'll attempt to tackle the issue of valuations.
To be sure, this is a tricky subject as the question of whether stocks are overvalued or undervalued usually resides in the eyes of the beholder. For example, one investor's overvalued view may be another's sign of positive momentum and strong growth. And so on.
There are many ways to assess the valuation of the market. The Grandaddy of valuation indicators has to be the Price-to-Earnings Ratio (PE). The concept here is simple. Take price and divide it by the earnings. This gives you the "multiple" that investors are willing to pay for the issue in question.
As you might suspect, there are many, many variations on the theme here. You can look at "trailing" (price relative to the last year's earnings) and/or "forward" PE's (price relative to the future earnings). Or the "median" (half above, half below) PE of the market. Or GAAP (generally accepted accounting principles) PE. Or... Well, you get the idea.
Of course, there are many others. Price-to-Sales. Price-to-Book Value. Price-To-Dividend. Etc.
Over the years, I've learned there are a couple of really important things to understand about the subject of valuations. The first, and perhaps the most important, is that the "multiple" investors are willing to pay for stocks changes over time. For example, when things are looking bright - as in the outlook for the economy and earnings - a higher multiple is generally applied. Whereas if the economy is slowing, inflation is high, or there is some form of external event threatening the future, investors become less confident and the multiple is usually at the lower end of the range.
Make No Mistake...
Oftentimes, there is an "argument" in the market about the state of market valuations. However, this is definitely NOT the case at the present time. In short, it doesn't matter which metric you use or which direction you look (backwards or forwards). The bottom line is valuations are high. As in, VERY high.
I have a list of about a dozen valuation indicators that I review on a monthly basis. One of the important takeaways on this blustery Monday morning is that ALL the valuation indicators are singing the same song right now. And the refrain is that the S&P 500's valuations are at levels only seen a few times before in history.
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