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I collaborate with my colleague Doug Short for some of the data I use in the article. Doug is an expert on market valuations, and I encourage readers to visit his site dshort.com
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. However, what a difference a month makes!
To see my previous market valuation article from last month click here.
The content will be mostly the same. I will be mostly updating the numbers, and the commentary as to what level the market valuations are at. I will be adding more historical data as I find it.
Below are six different market valuation metrics as of May 31st, 2010:
Current P/E TTM 18.1
The current P/E is 18.1 TTM, which is lower than the TTM P/E of 19.23 the market was valued at in late February. The P/E TTM is currently overvalued. However earnings are still low and the forward P/E is 15. However, I put little to no faith in forecasts so therefore I judge P/E based on the past and not on the future.
This data comes from my colleague Doug Short ofdshort.com.
Based on this data the market is moderately overvalued. However I do not think this is a fair way of valuing the market when considering the significant decrease in earnings over the past year. 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:
Mar 2009 110.37
Mar 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 [www.multpl.com]
Current P/E 10 Year Average 19.76
The 10 year P/E ratio is currently 19.76. This is below the measurement from my previous article of 21.99. This number is based on Robert Shiller's data evaluating the average inflation-adjusted earnings from the previous 10 years.
My colleague Doug Short thinks this 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 20.6.
Mean: 16.36
Median: 15.73
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 [www.multpl.com]
This is moderately over valued from the average P/E as shown above.
Current P/BV 2.1.
This is a very rough estimate, it is nearly impossible to get an exact number for P/B on a specific date to my knowledge.
The current P/BV is 2.1 , this is below P/B of 2.23 I measured in my previous article.
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 valued. 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 2.01
The current dividend yield of the S&P is 2.01. This number is lower than the 1.85 yield from my previous article.
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: 4.37%
Median: 4.30%
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 [www.multpl.com]
Current Stock Market Capitalization as percentage of GDP 78.1%
The current level of is 78.1% much lower than the 85% number than from my previous article.
Stock Market Capitalization as a percentage of GDP is another metric albeit less commonly used than other metrics, to value the market. Between 75-90% market capitalization as percentage of GDP is a fair value, therefore at a current level of 85%, the stock market is fairly valued. However, the ratio is getting close to being moderately undervalued.
:
| Ratio = Total Market Cap / GDP | Valuatoin |
|---|---|
| Ratio < 50% | Significantly Undervalued |
| 50% < Ratio < 75% | Modestly Undervalued |
| 75% < Ratio < 90% | Fair Valued |
| 90% < Ratio < 115% | Modestly Overvalued |
| Ratio > 115% | Significantly Overvalued |
| Today | Ratio =78.1%,Fairly valued |
Warren Buffett has stated that market capitalization as a percentage ofGNP 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 0.98
Tobins Q is 0.98 compared to 1.06 from last month.
The data comes from Doug Short. This is the most accurate data that is available. It is impossible 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 valuation. This is what Doug did to get the number
The current level of 0.98 compares with the Tobins Q's average over several decades of data of approximately .72. This would show that the market is slightly over valued. 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 Tobins Q .72 (source: Stocks for the Long Run
by Jeremy Siegel)In the next monthly article I will have more Tobin's Q historical data.
To Recap
1. P/E(TTM)- slightly overvalued
2. P/E(10 year average)- slightly overvalued
3. P/BV- Slightly undervalued
4. Divdend Yield- Indeterminate/ undervalued
5. Market value relative to GDP- fairly valued
6. Tobins Q- Overvalued
In conclusion the market is definitely not extremely over valued based on the above data. However, one can make the argument that the market is moderately overvalued. With the exception of P/BV all the indicators point to at least a slightly overvalued market.
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 most investors 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. I think with taking into account interest rates the market is fairly valued.
However, eventually the market will likely return to normal ratios as interest rates reach more normal levels. I believe returns over the next 10 years will be sub-par(below the 9.5% average market return). I think we will likely see returns of around that equal inflation over the coming decade.
I am humbly put myself in the same category as John Hussman, Robert Shiller, and Seth Klarman all who expect the broad market to stay approximately flat for the next 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
Disclosure: none
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.
Best Books on Market Valuations:
Valuing Wall Street : Protecting Wealth in Turbulent Markets
by Andrew Smithers. The book explains in detail how tobin's Q is calculated.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 correctly predicting the crash of it.About the author:
I am VP of Business Development for Sum Zero (http://sumzero.com), the largest community of buy-side analysts; consisting of over 5,900 hf and mf analysts, and over 3,600 extensive investment write-ups. I have prior experience in a value based pe firm focused on PIPE transactions in micro-caps, and at a value based research firm, which focused on smid caps. In my personal portfolio I have outperformed the market by a cumulative ~48% since 3/2008 (inception date). I can be contacted at jacob(at)sumzero.com for sumzero related inquires. My website is http://www.valuewalk.com/ Visit Jacob Wolinsky's Website
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