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Stock Market Valuation July 4, 2011

July 05, 2011
The market increased slightly over the past 30 days (including the close on July 1). However, some valuations went up while others went down.

The current level of the S&P500 is 1340, and the Dow is at 12,583 — slightly lower than last month. 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 collaborated with two colleagues of mine for some of the data in this article, Doug Short of Dshort, 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 10 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 click here

Below are eight different market valuation metrics as of July 2nd, 2011:

The current P/E TTM is 15.0, which is slightly lower than the TTM P/E of 15.8 from last month (this specific data is from the market close, June 30, 2011).


This data comes from my colleague Doug Short of

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 fairly 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 []

Current P/E 10 (Shiller) Year Average 23.67


The current ten-year P/E is 23.67; this is higher than the PE of 23.2 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 recently 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 in the danger zone. I think it is important to think of P/E in terms of earnings yield. So at 23.2 P/E you are getting a 4.3% earnings yield — not very attractive.

Ironically, it is likely easier to forecast market returns over the next 10 years than it is for tomorrow.

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


Stock MarketBest PossibleLuckyMost LikelyUnluckyWorst Possible
10-Year Percentage Returns8.085.082.08-0.92-3.92
20-Year Percentage Returns7.
30-Year Percentage Returns8.
40-Year Percentage Returns7.156.255.354.353.35
50-Year Percentage Returns7.186.385.584.884.18
60-Year Percentage Returns7.657.006.355.755.15
My colleague Doug Short thinks the Shiller’s 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 at22, still by no means cheap (these numbers are from the market close June 30th, 2011).


Mean: 16.40

Median: 15.78

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 []

Current P/BV ?


I have decided to remove P/B value. The main reason is that I saw that Horizon Asset management used the same numbers for P/B provided by Standard and Poor's and come up with a whopping 3.68% (for April). According to the same numbers that I used I came up with closer to 2.10%. Since, I cannot reconcile the two numbers I will discontinue it. The number that I used, I 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. But that does not account for the whopping difference between Horizon’s numbers and mine.

Unfortunately, there is very little data regarding P/B. I have been able to find close to no historic data on the metric. Additionally, my number was always an outlier which made me suspect my numbers might be wrong. I even had a Ph.D. student contact me to ask if there was any data available on price/book, and I told him no! If you are reading this and have any data I would be grateful if you sent it over.

The average price over book value of the S&P over the past 30 years has been 2.41. 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 (although book value can easily be distorted). 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. I will continue my search for PB numbers.

Current Dividend Yield 1.75


The current dividend yield of the S&P is [b]1.75
. This number is slightly lower than 1.72 from last month. The number is not so low considering the five-year Treasury is yielding 1.65%. For attractive yield check out my recent article about Australian debt-

It is hard to determine on this basis whether the market is overpriced. The dividend yield for stocks was much higher in the beginning 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 more 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: 4.34%

Median: 4.28%

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 []

Market Cap to GDP is currently 97.1%, which is higher than the 95.2% level 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 (07/04/2011)?Ratio = 97.1%, Modestly Overvalued

GuruFocus calculates the 4% 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 eight 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 eight years from current levels, the red line indicates the return if the market trends towards being overvalued (TMC/GNP=120%) over the next eight years. The brown line indicates the return if the market trends towards being fair valued (TMC/GNP=80%) over the next eight years.

The thick light blue line in the bottom right chart is the actual annualized return of the stock market over eight 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 October 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 eight 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

Current Tobin’s Q 1.05 (data as of market close June 30th, 2011)


Tobins Q is 1.05, lower than 1.19 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 1.05 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 two, 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 6/29/2011

38.31% Bullish

31.49% Neutral

30.19% Bearish

Individual investors are not very bullish. A large percentage are neutral.

Long-Term Average:

Bullish: 39%

Neutral: 31%

Bearish: 30%

Sentiment Survey Past Results

Reported DateBullishNeutralBearish
June 30:38.31%31.49%30.19%
June 23:37.46%26.80%35.74%
June 16:29.00%28.25%42.75%
June 9:24.42%27.91%47.67%

June 2:30.18%36.39%33.43%
May 26:25.61%32.97%41.42%
May 19:26.69%32.02%41.29%
May 12:30.77%33.73%35.50%
May 5:35.46%32.67%31.87%
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%

This is level indicates that investors not bullish. For all historic data on the AAII survey back to 1987 click on the following link - the collaboration of my colleague of 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 site, 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

GMO Chart:

7YR GMO Forecasts

To Recap

1. P/E (TTM) – Fairly Valued 15.0

2. P/E 10 year – Extremely overvalued 23.67

3. P/BV – xtremely overvalued - 3.68 (using numbers discussed above from April)

4. Dividend Yield – Indeterminate/ overvalued 1.72

5. Market value relative to GDP – Moderately Overvalued 97.1

6. Tobins Q – Extremely overvalued 1.19

7. AAII Sentiment – Average

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. But 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 10-year Treasury yield.

However, eventually the market will likely return to normal valuation ratios as interest rates reach more normal levels. I believe returns over the next 10 years will be subpar (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.

About the author:

Jacob Wolinsky
My investment ideas have been inspired by many of value investors including Benjamin Graham, Charles Royce, John Neff, Joel Greenblatt, Peter Lynch, Seth Klarman,Martin Whitman and Bruce Greenwald. .I live with my wife and daughter in Monsey, NY. I can be contacted jacobwolinsky(AT) and my blog is

Visit Jacob Wolinsky's Website

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