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Holly LaFon
Jacob Wolinsky
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Stock Market Valuation May 2, 2011

May 02, 2011

The current level of the S&P500 is 1,364, and the Dow is at 12,811–higher than last month, but valuations remained overall the same. As evidenced below, market valuations did not change much over the last month. I update market valuations on a monthly basis. The point of this article is to measure the stock market based on seven different metrics. This article does not look at the macro picture and try to predict where the economy is headed. It only uses these several metrics which have been very good past indicators of whether the market is fairly valued.

I collaborate with two colleagues of mine for some of the data in this article, Doug Short of Dshort (who got a very prominent mention in Barrons this week, in the second article, first paragraph), my friend who runs Seeking Delta (who recently changed jobs, and unfortunately no longer updates his sites), and Josh of Multipl. All are great sites, and I encourage readers to check them out.

As always, I must mention that just because the market is over or undervalued does not mean that future returns will be high or low. From the mid to late 1990s the market was extremely overvalued and equities kept increasing year after year. However, as I note at the end of the article I expect low returns over the next ten years based on current valuations. In addition, individual stocks can be found that will outperform or underperform the market regardless of current valuations.

To see my previous market valuation article from last month click here..

Below are six different market valuation metrics as of May 1, 2011:

The current P/E TTM is 15.9, which is slightly lower than the TTM P/E of 15.2 from last month (This specific data is from the market close, March 31, 2011).


This data comes from my colleague Doug Short of dshort.com.

Based on this data the market is fairly valued. However I do not think this is a fair way of valuing the market since it does not account for cyclical peaks or downturns. To get an accurate picture of whether the market is fair valued based on P/E ratio it is more accurate to take several years of earnings.

Numbers from Previous Market lows:

March 2009 110.37

March 2003 27.92

Oct. 1990 14.21

Nov 1987 14.45

Aug 1982 7.97

Oct 1974 7.68

Oct 1966 13.96

Oct 1957 12.67

Jun 1949 5.82

Apr 1942 7.69

Mar 1938 10.63

Feb 1933 14.92

July 1932 10.16

Aug 1921 14.02

Dec 1917 5.31

Oct 1914 14.27

Nov 1907 9.35

Nov 1903 11.67

Historic data courtesy of [multpl.com]

Current P/E 10 (Shiller) Year Average 24.1


The current ten-year P/E is 24.1; this is slightly lower than the PE of 24.11 from the previous month. This number is based on Robert Shiller’s data evaluating the average inflation-adjusted earnings from the previous 10 years. Robert Shiller stated in an interview last week that he believes the S&P500 will be at 1430 in 2020. Shiller believes that based on his metric the market is overvalued, and will offer subpar returns over the next 10 years. This number in my humble opinion is getting to the danger zone.

Based on my colleague, Rob Bennett’s market return calculator, the returns of the market should be as follows:


My colleague Doug Short thinks these numbers are a bit inaccurate because the number I used does not include the past several months of earnings, nor revisions. Doug calculates P/E 10 at 23, still by no means cheap (these numbers are from the market close March 31, 2011).


Mean: 16.40

Median: 15.77

Min: 4.78 (Dec 1920)

Max: 44.20 (Dec 1999)

Numbers from Previous Market lows:

Mar 2009 13.32

Mar 2003 21.32

Oct 1990 14.82

Nov1987 13.59

Aug 1982 6.64

Oct 1974 8.29

Oct 1966 18.83

Oct 1957 14.15

June 1949 9.07

April 1942 8.54

Mar 1938 12.38

Feb 1933 7.83

July 1932 5.84

Aug 1921 5.16

Dec 1917 6.41

Oct 1914 10.61

Nov 1907 10.59

Nov 1903 16.04

Data and chart courtesy of [multpl.com]

This is moderately over valued from the average P/E as shown above.

Current P/BV 2.16


The number is obtained using data from the spy ETF, and updated using the latest change in the price of spy. This number will therefore not be 100% accurate since the book value has likely changed (slightly) since the numbers were last updated on January 31.

The current P/BV is 2.15; which is the same as the P/B of 2.15 I measured in my previous article. Part of the reason for the decline might be due to the updated SPY numbers, which just became available for this article. These numbers include the change in book value and change in price; whereas most months I am only able to calculate for the change in price. However, these numbers seem to confirm that my methodology is pretty accurate as book value is not nearly as volatile as earnings.

The average Price over book value of the S&P over the past 30 years has been 2.41. This indicates the market is slightly undervalued. Book value is considered a better measure of valuation than earnings by many investors including legendary investor Martin Whitman. He states that book value is harder to fudge than earnings. In addition book value is less affected by economic cycles than one year earnings are. P/BV therefore provides a longer term accurate picture of a company’s value, than a TTM P/E.

Current Dividend Yield 1.72


The current dividend yield of the S&P is [b]1.72
. This number is slightly above the 1.71 yield from last month.

It is hard to determine on this basis whether the market is overpriced. The dividend yield for stocks was much higher in the begging of this century than the later half. The dividend yield on the S&P fell below the yield on ten-year treasuries for the first time in 1958. Many analysts at the time argued that the market was overpriced and the dividend yield should be higher than bond yields to compensate for stock market risk. For the next 50 years the dividend yield remained below the treasury yield and the market rallied significantly. In addition the dividend yield has been below 3% since the early 1990s. While I personally favor individual stocks with high dividend yields, I must admit that the current tax code makes it far favorable for companies to retain earnings than to pay out dividends. Finally, as I noted above the current economic environment has zero percent interest rates and low bond yields. During periods where yields are low it is logical for income oriented investors hungry for yield to be bid up the market, and dividend yields to decrease. I think it is hard to claim the market is overbought based on the low dividend yield.

Mean: 4.35%

Median: 4.29%

Min: 1.11% (Aug 2000)

Max: 13.84% (Jun 1932)

Numbers from Previous Market lows:

Mar 2009 3.60

Mar 2003 1.92

Oct 1990 3.88

Nov1987 3.58

Aug 1982 6.24

Oct 1974 5.17

Oct 1966 3.73

Oct 1957 4.29

Jun 1949 7.30

Apr 1942 8.67

Mar 1938 7.57

Feb 1933 7.84

July 1932 12.57

Aug 1921 7.44

Dec 1917 10.15

Oct 1914 5.60

Nov 1907 7.04

Nov 1903 5.57

Data and chart courtesy of [multpl.com]

Market Cap to GDP is currently 98.8%, which is higher than the 96.6% from last month.

Ratio = Total Market Cap / GDPValuation
Ratio< 50%Significantly Undervalued
50%< Ratio< 75%Modestly Undervalued
75%< Ratio< 90%Fair Valued
90%< Ratio< 115%Modestly Overvalued
Ratio > 115%Significantly Overvalued
Where are we today (05/02/2011)?Ratio = 98.8%, Modestly Overvalued

GuruFocus calculates the 3.5% return as follows:

The returns of investing in an individual stock or in the entire stock market are determined by these three factors:

1. Business growth

If we look at a particular business, the value of the business is determined by how much money this business can make. The growth in the value of the business comes from the growth of the earnings of the business growth. This growth in the business value is reflected as the price appreciation of the company stock if the market recognizes the value, which it does, eventually.

If we look at the overall economy, the growth in the value of the entire stock market comes from the growth of corporate earnings. As we discussed above, over the long term, corporate earnings grow as fast as the economy itself.

2. Dividends

Dividends are an important portion of the investment return. Dividends come from the cash earning of a business. Everything equal, a higher dividend payout ratio, in principle, should result in a lower growth rate. Therefore, if a company pays out dividends while still growing earnings, the dividend is an additional return for the shareholders besides the appreciation of the business value.

3. Change in the market valuation

Although the value of a business does not change overnight, its stock price often does. The market valuation is usually measured by the well-known ratios such as P/E, P/S, P/B etc. These ratios can be applied to individual businesses, as well as the overall market. The ratio Warren Buffett uses for market valuation, TMC/GNP, is equivalent to the P/S ratio of the economy.

What Returns Is the Market Likely to Deliver From This Level?

Putting all the three factors together, the return of an investment can be estimated by the following formula:

Investment Return (%) = Dividend Yield (%)+ Business Growth (%)+ Change of Valuation (%)

The first two items of the equation are straightforward. The third item can be calculated if we know the beginning and the ending market ratios of the time period (T) considered. If we assumed the beginning ratio is Rb, and the ending ratio is Re, then the contribution in the change of the valuation can be calculated from this:


The investment return is thus equal to:

Investment Return (%) = Dividend Yield (%) + Business Growth(%) + (Re/Rb)(1/T)-1

This equation is actually very close to what Dr. John Hussman uses to calculate market valuations. From this equation we can calculate the likely returns an investment in the stock market will generate over a given time period. In the calculation, the time period we used was 8 years, which is about the length of a full economic cycle. The calculated results are shown in the final chart to the right. The green line indicates the expected return if the market trends towards being undervalued (TMC/GNP=40%) over the next 8 years from current levels, the red line indicates the return if the market trends towards being overvalued (TMC/GNP=120%) over the next 8 years. The brown line indicates the return if the market trends towards being fair-valued (TMC/GNP=80%) over the next 8 years.

The thick light blue line in the bottom right chart is the actual annualized return of the stock market over 8 years. We can see the calculations largely predicted the trend in the returns of the stock market. The swing of the market’s returns is related to the change in interest rates.

It has been unfortunate for investors who entered the market after the late 1990s. Since that time, the market has nearly always been overvalued, only dropping to fairly valued since the declines that began in 2008. Since Oct. 2008, for the first time in 15 years, the market has been positioned for meaningful positive returns.

As of 04/03/2011, the stock market is likely to return 3.5% a year in the next 8 years.

Warren Buffett has stated that market capitalization as a percentage of GNP is “probably the best single measure of where valuations stand at any given moment.”

According to Barron’s the ratio got as low as 40% in the late 1940s, when investors feared another depression, and in the inflationary 1970s.

Historic Data:

Min 35% in 1982

Max 148% in 2000.

Data and charts courtesy of Gurufocus.com

Current Tobin’s Q 1.18 (data as of market close March 31, 2011)


Tobins Q is 1.18 is slightly higher than 1.17 from last month.



As can be seen from the above charts, the market is significantly over-valued based on tobins Q.

The data comes from Doug Short. This is the most accurate data that is available. It is impossible for the data to be 100% precise because the Federal Reserve releases data related to Tobin’s Q on a quarterly basis. The best that can be done is to extrapolate the data and try to provide the most accurate data possible based on the change in the Willshire 5000. This is what Doug and I did to get the current number. This method has proven extremely accurate for calculating Tobins Q on any given day.

The current level of 1.17 compares with the Tobins Q’s average over several decades of data of approximately .72. This would indicate that the market is extremely overvalued.

In the past Tobin’s Q has been a good indicator of future market movements. In 1920 the number was at a low of .30, the next nine years included phenomenal gains for the market. In 2000 Tobin’s Q almost reached a record high of nearly 2, and the market declined subsequently about 50% by 2003.

Historic Tobins Q:

Market Low 1932: 0.30

Market High 1929: 1.06 (This is not the highest number ever reached, just the number reached before the 1929 crash.)

Average historic Tobins Q .72 (source: Stocks for the Long Run by Jeremy Siegel)

AAII sentiment survey data from April 27th 2011;

37.9% Bullish

31.5% Neutral

30.06% Bearish

Sentiment Survey Past Results

Reported DateBullishNeutralBearish
April 28:37.90%31.45%30.65%
April 21:32.16%36.84%30.99%
April 14:42.25%26.76%30.99%
April 7:43.59%27.56%28.85%
March 31:41.81%27.12%31.07%
March 24:37.74%27.27%34.97%
March 17:28.49%31.40%40.12%
March 10:35.98%31.71%32.32%
March 3:36.79%30.05%33.16%
February 24:36.63%27.23%36.14%
February 17:46.58%27.85%25.57%
February 10:49.40%23.69%26.91%
February 3:51.54%21.59%26.87%
January 27:42.04%23.67%34.29%
January 20:50.75%20.15%29.10%
January 13:52.34%24.22%23.44%
January 6:55.88%25.86%18.25%
December 30:51.61%28.34%20.05%
December 23:63.28%20.31%16.41%
December 16:50.23%22.62%27.15%
December 9:53.05%24.39%22.56%

This is level indicates that investors are only slightly bullish. For all historic data on the AAII survey back to 1987 click on the following link -http://www.aaii.com/sentimentsurvey/sent_results With the collaboration of my colleague ofhttp://seekingdelta.wordpress.com/ I have now added a seventh metric for valuing the market. This data comes from the survey conducted by the American Association of Individual Investors (AAII) conducted on a weekly basis. According to the AAII, “The AAII Investor Sentiment Survey measures the percentage of individual investors who are bullish, bearish, and neutral on the stock market for the next six months; individuals are polled from the ranks of the AAII membership on a weekly basis. Only one vote per member is accepted in each weekly voting period.”

(Note: Seeking Delta has stop updating his cite, and these charts are a bit outdated)


Below is AAII data from previous market bottoms (the AAII began the survey in 1987).The charts essentially show that on average, returns have been more favorable when bullish sentiment is below 28% vs above 50%. The one-year average return when sentiment is above 50% is 1.9% vs. 13.6% when sentiment is below 28%.



Bullish Neutral Bearish

March 2009 18.92% 10.81% 70.27%

March 2003 34.3% 14.30% 51.40%

Oct. 1990 13.00% 20.00% 67.00%

Nov. 1987 31.0% 41.00% 28.00%

Average 39.00% 31.00% 30.00%

Max 75.00% 62.00% 70.00%

Min 12.00% 8.00% 6.00%

Chart and data courtesy of http://seekingdelta.wordpress.com/

GMO Chart:

April 2011: GMO Forecast for Next Seven Years

To Recap

1. P/E (TTM) – Fairly Valued 15.9

2. P/E 10 year – Extremely overvalued 24.11

3. P/BV – Undervalued - 2.16

4. Dividend Yield – Indeterminate/ overvalued 1.72

5. Market value relative to GDP – Moderately Overvalued 98.8

6. Tobins Q – Extremely overvalued 1.18

7. AAII Sentiment – Investors are slightly bullish

8. GMO – Overvalued

In conclusion, the market is overvalued based on the above data. Tobins Q, Shiller PE and AAII data are all indicating that investors are too bullish and valuations are too high.

However, the historical data fails to take into account current record low interest rates. I know not many investors take issue with my inclusion of interest rates in the equation. However, I think that investors should look at the stock/bond alternative. Right now you can get some blue chip stocks with dividend yields close to the Ten year treasury yield.

However, eventually the market will likely returns to normal valuation ratios as interest rates reach more normal levels. I believe returns over the next 10 years will be sub-par (far below the 9.5% average market return). I think we will likely see returns equal to inflation over the coming decade.

You can read more about my predictions in the following two articles:

What Will The S&P 500 Return Over The Next 10 Years Part I

What Will The S&P 500 Return Over The Next 10 Years Part II

Note: I have received numerous suggestions on how to improve my monthly series. I tried to incorporate these ideas in my current article. Please email me or leave a comment if you would like to provide further suggestions.

Stay tuned till the beginning of next month for the next monthly valuation article.

Valuing Wall Street: Protecting Wealth in Turbulent Markets by Andrew Smithers. The book explains in detail how tobin’s Q is calculated.

Wall Street Revalued: Imperfect Markets and Inept Central Bankers. A more recent book by Andrew Smithers.

Irrational Exuberance by Robert Shiller. Great book by the man who calculates the P/E 10 ratio himself; Robert Shiller. The book is written in 2000, right before the tech bubble crash. Shiller correctly predicts the crash. Shiller also accurately predicted the housing bubble.May

Rating: 4.3/5 (19 votes)


Alex Morris
Alex Morris - 5 years ago    Report SPAM

Thanks as always for the market update. Quick question: in Rob Bennett's market return calculator, the predicted logically deviates towards the historical return over long term periods. However, for some reason, the 30 year duration unexpectedly is higher; any insight on this? Thanks!
Yswolinsky - 5 years ago    Report SPAM
I made a typo in one of the last paragraphs about the AAII survey from the end, it was from a prior month where bullishness was far higher.
Rob Bennett
Rob Bennett - 5 years ago    Report SPAM
In Rob Bennett's market return calculator, the predicted logically deviates towards the historical return over long term periods. However, for some reason, the 30 year duration unexpectedly is higher; any insight on this?

Thanks for showing some interest in the Return Predictor, Alex.

I believe that it is just a quirk of the data.

The calculator is based on the historical record of data going back to 1870. The data generally matches what you would logically expect to see. But there are small deviations from what you would expect to see here and there. I believe that these bumps will be smoothed out over time as more data is added to the mix. But the fellow who did the statistical work for the calculator (John Walter Russell, owner of the www.early-retirement-planning-insights.com site) did not himself smooth out the bumps. He just let the data tell the story that it tells.

Alex Morris
Alex Morris - 5 years ago    Report SPAM

Thanks for the response; figured it might just be a quirk, but wanted to make sure. Thanks for the valuations!
Rjstcr premium member - 5 years ago
Jacob; Thanks much for these. Very informative. Ron
Bill Smith
Bill Smith premium member - 5 years ago
Jacob: thanks for continuing to do this summary. I've personally been using it for well over 18 months.



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