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High-Flying Stocks Still a Good Value

Mark Smith, CFP®, CPA/PFS, CIMA® - Wednesday, April 19, 2017

Stocks are Not Overvalued | Denver Financial PlannerIf you read last Saturday’s Wall Street Journal, you saw that the stock market is raising investor concerns again. A decline in the consumer price index, a lackluster labor report, and a 24-percent rise in the CBOE Volatility Index (VIX), among other indicators, have some investors worried about whether the market is overvalued. In fact, the Wall Street Journal quoted one investment professional who reduced his exposure to large-company stocks out of concern that all the optimism and good news has already been priced in, and volatility is sure to follow.

As of April 13, the S&P 500 stood at 2,328, and while it is down about three percent from its March record, it’s still flying high. But is it overvalued? Let’s examine the issue from a variety of perspectives.

If you look at the consensus, forward-earning estimates of the S&P 500 are around $133, and the price/earnings (P/E) ratio is 17.4, while the trailing 25-year P/E ratio (as calculated by J.P. Morgan Asset Management) has averaged 15.9. This could lead some to believe that the stock market is indeed overvalued by about 10 percent.

Now, let’s evaluate one of the other major asset classes that people can choose to invest in: the bond market. Consider the 10-year Treasury bond, which, as of April 13, had yields at 2.23 percent. The yield over the last 25 years, again, according to J.P. Morgan, has averaged about 4.5 percent. In this case, on a relative basis, stocks at this point appear much more competitive than bonds. 

Let’s look at it another way. If you were to take the earnings of the S&P 500 and divide it by the price (as of April 13), you’d see that the stock yield was 5.75 percent. Assuming you had no growth in earnings (which is hardly likely, considering that corporate earnings have always grown over time), it would take you 18 years to earn back the original principal you had invested. If you invested in 10-year bonds at 2.23 percent, however, it would take you 45 years to recover your initial investment. Which would you rather invest in?

At M.J. Smith & Associates, we don’t believe in timing the market, and we’re firm believers in maintaining a broadly diversified portfolio that includes both stocks and bonds. Volatility is common, and I believe we’re overdue for a market correction, but in my opinion, those who pull out of the stock market at this point could miss out on any gains that will inevitably occur in the future. While past performance is no guarantee of future results, corporate profits should continue to grow over time, and the markets will reflect that.

Perhaps the legendary Peter Lynch, the former Magellan fund manager at Fidelity, said it best. In an interview with PBS in the mid-1990s, he made a statement that still resonates today: “Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves.” Even today, that’s sound advice.

If you have concerns about the stock market, I encourage you to contact us. Our entire team remains committed to your financial well-being, and we’re here to answer any questions you may have. As always, it’s our privilege to serve you.

 

 

 

This information does not purport to be a complete description of the securities, markets, or developments referred to in this material; it has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. This information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Opinions expressed are those of Mark Smith and are not necessarily those of Raymond James. All investing involves some degree of risk, investors may incur a profit or loss regardless of the strategy or strategies employed. Diversification does not ensure a profit or guarantee against loss. Examples provided are hypothetical and have been included for illustrative purposes only. Past performance does not guarantee future results. The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market. The Chicago Board Options Exchange (CBOE) Volatility Index, shows the market's expectation of 30-day volatility. It is constructed using the implied volatilities of a wide range of S&P 500 index options. Keep in mind that individuals cannot invest directly in any index, and index performance does not include transaction costs or other fees, which will affect actual investment performance. Individual investor's results will vary. The price earnings ratio (P/E Ratio) is the ratio for valuing a company or index that measures its current share price or prices relative to its per-share earnings. Links are being provided for informational purposes only. Raymond James is not affiliated with and does not endorse, authorize or sponsor any of the listed websites or their respective sponsors. Raymond James is not responsible for the content of any website or the collection or use of information regarding any website's users and/or members. Raymond James is not affiliated with Peter Lynch.

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