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Chuck Carnevale
Chuck Carnevale
Articles (281)  | Author's Website |

Based on Real Math the S&P 500 Is Fairly Valued

October 24, 2012 | About:

As investors, we do not believe in forecasting stock markets or stock prices on individual stocks. Instead, we approach investing as the process of calculating intrinsic value based on fundamentals. To us, the most important fundamental to be considered when evaluating the True Worth™ of a market or a common stock is earnings. Therefore, it's important that the reader understands that this article is offered as a mathematical calculation of what the S&P 500 is actually worth based on earnings. The reason we believe this to be important is because we also believe that any deviations from fair value will ultimately self-correct.

As we will soon illustrate, in the short run the stock market has a penchant for grossly mispricing common stocks and broad indices. When this is occurring, it is extremely valuable and important for investors to be able to recognize extreme and/or erroneous valuations when they manifest. It is also our contention that the calculation of fair valuation is both practical and achievable. In contrast, we further believe that attempting to forecast short-term market or price movements to be an exercise in futility. When irrational behavior is rampant, there is no logic that can be applied.

Our point is, making investment decisions based on valuation is a sound exercise that will bear fruit long term. As already stated, in the shorter run prices can go beyond fair value or below it. But, inevitably stock prices will seek intrinsic values. Therefore, we believe that intrinsic value is something that can be trusted, whereas stock price volatility cannot. Admittedly, this is not as easy as we may be making it appear. The trick lies in forecasting future earnings as accurately as possible. The better you can do that, the more accurate your long-term forecast will be. But, once again, we contend that forecasting earnings can be done more accurately than attempting to forecast short-term price movement. On the other hand, this is easier to do on an individual company (business), than it is on a broad index like the S&P 500.

Historically Normal Valuations

When writing articles such as this, many authors tend to gravitate towards statistical references. And, although there can be value found through statistical analysis, it's also very easy to draw erroneous conclusions. With that said, there is a preponderance of historical data, and calculations based on that data, that the historical normal PE ratio for the S&P 500 is 15. However, even more importantly, we believe that there is a rational mathematical explanation for why a PE of 15 represents the proper average valuation for most companies and therefore, an index like the S&P 500.

A detailed explanation of the mathematical validity of the PE-equals-15 thesis is beyond the scope of this article. However, a brief explanation of the underlying principles should suffice. The normal PE of 15 is based on the reality that a stream of income generated from an investment is worth more than one times earnings. This is true even if the future income stream does not grow. In other words, if we assume, for example, an interest rate of 8.5% on a bond (of course bond yields are much lower than that today), we would discover that the bond is trading at approximately 12 times interest. Since the future income stream on a bond is fixed, it only stands to reason that a growing income stream, such as found on a stock, should also command a multiple greater than one, adjusted for risk.

That number has historically hovered around a PE of 15, because this represents an earnings yield of 6%-7%. This number is very close to the long-term historical returns that stocks have delivered on average. Admittedly, we have not provided significant proof of our statement based on what is written above. Instead, we are simply offering some hints as to how the normal PE of 15 can be justified. Put another way, there is a lot of research that suggests that the normal PE ratio for the S&P 500 over the past 100-plus years is 15. Additionally, there is further research that indicates that the normal PE ratio for the S&P 500 over the past 20 years has been closer to 20 (19.3 on our graph below). Our analysis, and a quick glance at the earnings- and price-correlated graph below, indicates that this higher-than-normal PE over the past 20 years can be mostly attributed to excessive overvaluation.

The S&P 500 via F.A.S.T. Graphs™

When looked at through the lens of our F.A.S.T. Graphs™ research tool, we can test theory and see how it applies in the real world. The following earnings and price correlated graph of the S&P 500 since calendar year 1994 tells some interesting stories. Perhaps the most interesting story is how the chart depicts two calculated PE ratios that equal the 20-year historical normal PE of approximately 20 (19.3), and the longer-term normal PE ratio of 15. In the first case, the PE of 20 (blue line with asterisks) was determined as the computer calculated the trimmed mean (outlier highs and lows trimmed to eliminate skewing) PE ratio for that time period. In the second case, the PE of 15 was determined by applying a widely accepted formula for valuing businesses to the EPS growth rate of 7.5% for the S&P 500 since 1994.

The important takeaway from reviewing the earnings- and price-correlated graph is the visual depiction of how statistics can mislead. Clearly, the black monthly closing stock price line often deviated significantly above and below the trimmed mean PE ratio of 20. Therefore, even though it is statistically accurate to state that the normal PE over this time frame was 20, a quick visual shows how often that was not true. As previously stated, we believe that the graph vividly illustrates the meaning of the phrase “irrational exuberance."

On the other hand, we believe the graph further vividly illustrates how the black monthly closing stock price line continuously attempted a reversion to the mean towards a historically significant normal PE of 15. The reader should note that although all data is plotted, when we draw a graph of 20 years, we only type in every other year’s data because of space restraints (note the asterisks by the years at the top of the graph).



In conclusion, there continues to be a lot of opinion and speculation regarding whether the S&P, or the stock market or stock prices in general are overvalued or not. From the perspective of earnings justified valuations as depicted in the graph above, at 14.1 times earnings, it is arguable that the S&P is slightly undervalued at these levels. Moreover, taken directly from its website, the current forecast for operating earnings of the S&P 500 by Standard & Poor's Corp. is $101.33. If this forecast is accurate, it would imply a year-end fair value for the S&P of approximately 1519.40.

Mathematically, it would indicate that the S&P has approximately another 7.52% upside by year-end. Once again, this is not a prediction, but a mathematical calculation based on applying a normal PE ratio of 15 to the current earnings expectations of the S&P. It is our intention to provide an updated F.A.S.T. Graphs™ on the S&P periodically. If forecasts change, so will the anticipated valuation expectations.

Disclosure: I have no positions in any stocks mentioned and no plans to initiate any positions within the next 72 hours.

Disclaimer: The opinions in this document are for informational and educational purposes only and should not be construed as a recommendation to buy or sell the stocks mentioned or to solicit transactions or clients. Past performance of the companies discussed may not continue and the companies may not achieve the earnings growth as predicted. The information in this document is believed to be accurate, but under no circumstances should a person act upon the information contained within. We do not recommend that anyone act upon any investment information without first consulting an investment adviser as to the suitability of such investments for his specific situation.

About the author:

Chuck Carnevale
Charles (Chuck) C. Carnevale is the creator of F.A.S.T. Graphs™. Chuck is also co-founder of an investment management firm. He has been working in the securities industry since 1970: He has been a Partner with a private NYSE member firm, the President of a NASD firm, Vice President and Regional Marketing Director for a major AMEX-listed company, and an Associate Vice President and Investment Consulting Services Coordinator for a major NYSE member firm.

Prior to forming his own investment firm, he was a partner in a 30-year-old established registered investment advisory in Tampa, Florida. Chuck holds a Bachelor of Science in economics and finance from the University of Tampa. He is a sought-after public speaker who is very passionate about spreading the critical message of prudence in money management. Chuck is a veteran of the Vietnam War and was awarded both the Bronze Star and the Vietnam Honor Medal.

Visit Chuck Carnevale's Website

Rating: 3.3/5 (23 votes)


LwC - 5 years ago    Report SPAM
In think I'll go with Ned Davis Research per John Hussman on this issue:

According to Ned Davis Research, stock market capitalization as a share of GDP is presently about 105%, versus a historical average of about 60% (and only about 50% if you exclude the bubble period since the mid-1990’s). Market cap as a fraction of GDP was about 80% before the 73-74 market plunge, and about 86% before the 1929 crash. 105% is not depressed. Presently, market cap is elevated because stocks seem reasonable as a multiple of recent earnings, but earnings themselves are at the highest share of GDP in history. Valuations are wicked once you normalize for profit margins. Given that stocks are very, very long-lived assets, it is the long-term stream of cash flows that matters most – not just next year’s earnings. Stock valuations are not depressed as a share of the economy. Rather, they are elevated because they assume that the highest profit margins in history will be sustained indefinitely (despite those profit margins being dependent on massive budget deficits – see Too Little to Lock In for the accounting relationships on this). In my view, there are red flags all around.


JUDS1234567 - 5 years ago    Report SPAM
I agree with the previous commentator. Shiller PE 10 as well as Tobin Q and Crestmont PE are all at market top valuations. Lets not forget the venerable Jeremy Grantham whose 7 year forecast has indicated negative or near negative returns for large indexes. Yes that’s right you may even loose money or come out even! Also Buffett GPD/Market Cap ratio indicates overvaluation. The market is not cheap or fair valued.The industry always has a bullish slant to it. Earnings are based on profit margins which are as previosuly stated at record highs, and when those collapse earning will not reflect correct value, that is why its always better to take an average.

For those of us who study secular phases in markets let us not forget 2000. Secular bears are always marked by a compression in valuation. No secular bear before has ended without a low in single or near single PE’s so if the pattern holds 1906-1921, 1929-1949, 1966-1982 and now 2000-? will have better time to deploy cash.Let us hope a Japan type market does not await us. So one can argue the market is fair valued based on one year earnings(which I disagree) or wait to deploy cash at better valuations, which WILL present themselves.

And for those of you who claim Buffett is not a Macro/Market Timer take note of his decision to exit the market in the Go Go 60’s at market top. In addition Buffett exited many stock postions in 2000 also at the market peak as well, both times he was wating at the bottom of the bear ready with cash 73 and 02-03 respectively. Make no mistake these are near Bubble valuations we are in. The Secular Bear leaves little doubt to this “fair value” market.

Tafakis - 5 years ago    Report SPAM
LwC, without having done much research on the topic, does it make sense for the S&P500 to rise as a fraction of GDP due to globalization?

1) The S&P 500 includes multinationals, which increasingly earn income abroad, so US GDP is a misleading comparison

2) Within the US, the economy has experienced consolidation (survival of the fittest) and thus the companies of the &P 500 constitute to a larger part of the economy

JUDS, regarding earnings margins, I agree they are at record highs but also there are some explanations:

1) Interest rates have dropped, which translated into lower borrowing cost and thus less interest payments

2) Corporate tax rates have been falling

3) Labour income as a percentage of GDP has been falling

All of the above impact positively on margins, and while some mean reversion is ought to occur, comparing them to completely different tax, interest rate environments will yield an overly pessimistic result

Overall I agree with the author, the market is probably fairly valued.
JUDS1234567 - 5 years ago    Report SPAM
Tafakis, you reasons are valid and I do agree on some of them. However, the real question is are these factors sustainable? Particularly interest rates which are not static(History shows us they alternate in generational swings) and taxes? The fact of the matter is that different measures with far better track records than the authors indicate frothy markets. My favorite is of course Tobin's Q, I can go trough a very well detailed exlpanation on its validity. I recommend Andrew Smiithers book- Valuing Wall street. Either way although Hussman is a bit cautious for my taste, his methodology has been more or less right since 2000. And for those of us who follow Hussman, his lackluster record as of late was partly from NOT investing during the 09 low when his methodolgy indicated the market as reasonably cheap. With respect, I do feel that the reasons listed are just another case of "its different this time"

History shall prove us wrong or right

LwC - 5 years ago    Report SPAM
Sorry Tafakis, but I don't know how to answer your questions. I was merely pointing out that Ned Davis Research has presented a different perspective from the author's, but IMO they are not necessarily mutually exclusive. Ned Davis Research is well known for a long time for their historical surveys of financial markets. AFAIK they do not generally try to make predictions about the future; rather they seek to put current financial markets into an historical perspective. One is free to make their own conclusions.

I suggest that you direct your questions to Ned Davis Research. I'll be interested in their response.

As for the author's assertion that the S&P500 is "fairly valued" based on long term historical P/E averages, well certainly that is a controversial conclusion. As you probably are aware, others have different opinions about that. Notable is Robert Shiller who argues that based on his "normalized earnings" calculation of the S&P500 value, it is overpriced by about a third. The author appears to implicitly acknowledge this by pointing out that using his black box calculator limited to just the past twenty years, the S&P500 has averaged P/E of about 20, which is significantly above the longer term average, and is not much different from Shiller's calculation based on his ten year average.

Regardless, IMO it's important that one understands that the author appears to be relying on at least two assumptions that may or may not prove to be appropriate:

1. He states that he is "applying a widely accepted formula for valuing businesses to the EPS growth rate of 7.5% for the S&P 500 since 1994." Why 18 years? Why not ten years, or 50 years? Is it reasonable to assume that if the S&P500 EPS growth rate was 7.5% over the last 18 years, it will continue to be so into the future?

AFAIK most people who study these issues believe that on average earnings grow at about the rate of GDP growth.

"According to economist Robert Shiller, earnings per share on the S&P 500 grew at a 3.8% annualized rate between 1874 and 2004 (inflation-adjusted growth rate was 1.7%).[2] Since 1980, the most bullish period in U.S. stock market history, real earnings growth according to Shiller, has been 2.6%."


Please note the huge difference between Shiller's calculation of real earnings growth of 2.6% since 1980, and the author's assumed growth rate of 7.5% since 1992 (I not sure that the author's assumed growth rate is adjusted for inflation like Shiller's, so the comparison is questionable.)

Anyway I find it peculiar that the author chose an 18 year period to bolster his case for 7.5% earnings growth. I mean, why not a round number like say 20 years? Did the author pick an odd number of years just to make his argument look better? But even more to the point, what is the author's argument for earnings growth to continue to be well above the long term average, and well above the growth of GDP?

2. The author states that he is relying on the Standard & Poor's Corp. prediction for future earnings of the S&P500, which may or may not prove to be accurate. As the author points out in the article, S&P appears to be estimating those future earnings based on the assumption that the S&P500 earnings will increase at the 18 year average of about 7.5%. Robert Shiller has recently asserted that the earnings are not as high as many think they are, but of course he is biased towards his "normalized earnings" metric:


Furthermore if you do a search for comparisons of predicted earnings vs. actual earnings obtained, IMO you will become skeptical about the prognosticators' ability to accurately predict the future earnings.

At the end of the day, what does it all matter? If one is a "value investor", presumably one is concerned with identifying companies that are selling at some discount to the investor's estimate of intrinsic value, regardless of whether a stock broker thinks the S&P500 is "fairly valued" or not.

Chuck Carnevale
Chuck Carnevale - 5 years ago    Report SPAM

Here is my response to the same comment written by JUDS1234567 on another blog,


Very interesting comment. However, allow me to clarify a few things about FAST Graphs. First and foremost, our Fundamentals Analyzer Research tool is primarily designed to analyze the earnings and price relationship of individual businesses in addition to several other fundamental metrics. In contrast to most, we focus on the business behind the stock, over the price, as most charting tools do. We get our data from S&P capital IQ, and only offer 20 years (actually 18-20 currently we only go back to 1994). Ergo we offered as long a period of history that was available to us.

Regarding your point number 1, there is no assumption in the historical EPS growth rate, that number is the actual calculated historical growth since 1994. Furthermore, we made no representation that S&P 500 forward growth would average 7.5%, we only reported actual historical for the time frame graphed. All the Schiller data you quote is irrelevant to my thesis or my valuation calculations. Not really interested in 1874. Furthermore, adjusting for inflation is not relevant because all investments have to be adjusted. Knowing the actual growth is more meaningful to me. If you disagree, that is your prerogative.

Regarding point number 2, the forecast is not 7.5% growth. 2012 growth is forecast at 5%, and 2013 is 13% which comes precisely from the S&P website. Here is a link, go to download index data then download index earnings to open the excel spreadsheet:


Regarding future earnings estimates, after 40 years of using them I can attest that they are a lot more accurate than they are given credit for. First of all, they are after all estimates, and it would be naïve to expect perfection. Most estimates come within a very reasonable range of accuracy, and an acceptable margin for error. Furthermore, they are provided by the leading financial analysts covering the companies, after extensive research into their fundamentals and peer comparisons etc. Also, they receive much of their info from the companies themselves. Nevertheless, we encourage subscribers to do their own work if possible, and provide the opportunity to input their own numbers if they chose. But I am comfortable relying on the leading experts who have done their homework.

In closing, FAST Graphs are designed to analyze individual companies. However, since we get S&P 500 data, I show it to provide factual perspectives based on actual numbers. But as I indicated in my dialogue, I do not believe in predicting markets, only companies. But frankly, I get tired of all the rhetoric about stocks being expensive, when the facts say otherwise. I have actually reviewed every single one of the S&P 5oo constituents and can tell you that there is a lot of value in this market, contrary to popular belief. I authored a 5 part series of articles on this subject follow this link to my first if you are interested in gathering facts:


But my biggest confusion with yours and many of the comments on this thread is the unwillingness to review the facts as they exist. No statistical manipulation ala Schiller etc, but just the raw facts. So my appeal is don’t shoot the messenger.



Tkervin - 5 years ago    Report SPAM
"What Goes Up Must Come Down" by James Montier is instructive. (Link would not paste)

The "E" of P/E has always reverted to the mean...and always there are those who argue.."This time it is different."

I have yet to see that happen in the forty plus years I have followed the market.

Is this that time?

JUDS1234567 - 5 years ago    Report SPAM
I enjoy the discussion, it provides an opportunity for learning. And I am most interested in a opposing point of view. And technically yes, using the last 20 or so years of data the market (as represented by the SP 500) would seem fairly valued. The previous comment seemed to make fun of using data going back to 1874, that’s a shame. Why would we be not interested in different environments, different interest rates, sentiment ect. To quote the Good Book “there is nothing new under the sun” or perhaps NO THIS TIME IS NOT DIFFERENT and my favorite “The more things change the more they stay the same”.

The fact of the matter using the last 20 years is not long enough at least a data set capturing the last of the great bear. In fact your critique of Shiller seems a bit harsh especially considering Shiller based his approach to Benjamin Graham valuing the market in averages as outlined in Security Analysis. No other measure of valuation has had as much success in at least predicting future returns. I do admire the work Mr. Carnevale produces and read his other articles with much passion. If you pick the right stocks you will outperform, be it the dividend growth stocks or some lucky shot like Apple. If you put 10000 into Coke back in 2000 you still be coming out slightly ahead… that’s not the argument here. There is a lot of value (though not as much as before 2010-2011) in this market. BUT the fact of the matter and unrelated to individual stock selection is the SP 500, and on this I will agree to disagree. NO the market is not fair valued when one normalizes for margins or uses other rigorous methods encompassing more than 20 years of examination. Take Tobin Q I direct you here:

This has a great amount of evidence and introduces other valuation methods to verify one another


In addition to the Shiller PE 10, and Q ratio we also have The Crestmont Research P/E Ratio, The relationship of the S&P Composite price to a regression trendline method of valuation. I did not include buffet famous GDP/Market Cap valuation tool.

Let me say one more thing to compare Shiller PE to the Trailing Twelve Month (TTM )PE as presented in this article.

A standard way to investigate market valuation is to study the historic Price-to-Earnings (P/E) ratio using reported earnings for the trailing twelve months (TTM). Proponents of this approach ignore forward estimates because they are often based on wishful thinking, erroneous assumptions, and analyst bias.

TTM P/E Ratio

The "price" part of the P/E calculation is available in real time on TV and the Internet. The "earnings" part, however, is more difficult to find. The authoritative source is the Standard & Poor's website, where the latest numbers are posted on the earnings page. (See the footnote below for instructions on accessing the file).

The average P/E ratio since the 1870's has been about 15. But the disconnect between price and TTM earnings during much of 2009 was so extreme that the P/E ratio was in triple digits — as high as the 120s — in the Spring of 2009. In 1999, a few months before the top of the Tech Bubble, the conventional P/E ratio hit 34. It peaked close to 47 two years after the market topped out.

As these examples illustrate, in times of critical importance, the conventional P/E ratio often lags the index to the point of being useless as a value indicator. "Why the lag?" you may wonder. "How can the P/E be at a record high after the price has fallen so far?" The explanation is simple. Earnings fell faster than price. In fact, the negative earnings of 2008 Q4 (-$23.25) is something that has never happened before in the history of the S&P 500.

The P/E10 Ratio

Legendary economist and value investor Benjamin Graham noticed the same bizarre P/E behavior during the Roaring Twenties and subsequent market crash. Graham collaborated with David Dodd to devise a more accurate way to calculate the market's value, which they discussed in their 1934 classic book, Security Analysis. They attributed the illogical P/E ratios to temporary and sometimes extreme fluctuations in the business cycle. Their solution was to divide the price by a multi-year average of earnings and suggested 5, 7 or 10-years. In recent years, Yale professor Robert Shiller, the author of Irrational Exuberance, has reintroduced the concept to a wider audience of investors and has selected the 10-year average of "real" (inflation-adjusted) earnings as the denominator. As the accompanying chart illustrates, this ratio closely tracks the real (inflation-adjusted) price of the S&P Composite. The historic average is 16.4. Shiller refers to this ratio as the Cyclically Adjusted Price Earnings Ratio, abbreviated as CAPE, or the more precise P/E10, which is my preferred abbreviation.

The Current P/E10

After dropping to 13.3 in March 2009, the P/E10 rebounded to an interim high of 23.5 in February of last year and is now at 21.5. The next chart gives us a historical context for these numbers. The ratio in this chart is doubly smoothed (10-year average of earnings and monthly averages of daily closing prices). Thus the fluctuations during the month aren't especially relevant (e.g., the difference between the monthly average and monthly close P/E10).

Of course, the historic P/E10 has never flat-lined on the average. On the contrary, over the long haul it swings dramatically between the over- and under-valued ranges. If we look at the major peaks and troughs in the P/E10, we see that the high during the Tech Bubble was the all-time high above 44 in December 1999. The 1929 high of 32.6 comes in at a distant second. The secular bottoms in 1921, 1932, 1942 and 1982 saw P/E10 ratios in the single digits.

As for the Q ratios the following PDF file found here:


The Dao of Corporate Finance, Q Ratios, and Stock Market Crashes (June 2011)

Mark Spitznagel, Chief Investment Officer

The Q Ratio takes into account total price of the market divided by the replacement cost of all its companies. So we have something else besides earnings to verify market valuation thesis.

But of course the crux of the matter are profit margins……which is where the esteemed Mr. Carnevale and myself disagree as such allow me to have the masters speak for me:

1. Profit Margins and thus earnings will revert and one must normalize for margins, The list of credible market veterans is astounding……

Jeremy Grantham:

"If profits aren't mean-reverting, then capitalism is broken."

“And GMO is pretty academic, sometimes to its cost, and so we ruthlessly normalize earnings to very long-term averages. And that's what separates us from most of the data. People think the American market is very cheap, in general. A great majority think it's reasonably cheap, and we don't, because we want it to be priced to the normal earnings. And the bulls say, well, of course, there's been a paradigm shift. Profit margins are higher and always will be higher, because that's what bulls like to say. And we say, other things being equal, we'll always bet on the average--profit margins will come down.

And think how weird profit margins are. We have high unemployment. We have lots of things going wrong. We have, I think, a justifiably scary world, and yet we have world-record profit margins. It is truly weird. It has never occurred before.

According to my colleague, Ben Inker, and some economists over the years, there is a relationship between rising government debt and profit margins. As government debt rises, other things being equal, underlined three times, profit margins tend to go up. And when they start to pay down the debt, other things being even, profit margins come down, and that seems pretty plausible in today's situation, but it gives you this artifact, and it's a prop to the market: world-record earnings. And they are believed by most people, but not GMO. And so they look at the P/E on these astronomical earnings, and they say, oh boy, the market is really cheap, so that even though I'm nervous, I don't necessarily have to sell my stocks at such a bargain price. And, in fact, American stocks are a little expensive, and as earnings turnover, which they are doing now, I was worrying over breakfast that people would see that, oh my, earnings are not what we thought they were. And that would give a nervous marketplace a pretty good excuse to come down. So it's kind of offsetting errors. The market wants to be nervous, thinks it's being nervous, and thinks it's priced the market accordingly, but only because it quite incorrectly gives full credit to today's earnings. So I think that is food for thought.” -From Morningstar investment conference

“Thank heavens for all the value managers in the world--there is an underlying reality, which has a huge pull. Sooner or later, things will trade at replacement cost. If you can't build a polyethylene plant because the prices are too low, you stop building, everybody stops building, years go by, there is a shortage, the price starts to rise, and eventually you sharpen your pencil, you can build a new plant, and make a profit, and you do, and the cycle turns. “

-From Morningstar investment conference (notice how he hints at Q ratio ie replacement cost )

“This is allocation--principles you need to know. Mean reversion drives everything. Everything is always going to go back to normal, with one exception that we'll get to. Markets are shockingly inefficient, of course. Wait for the fat pitch. Don't tickle the market to death. Wait and wait and wait and wait, and then hit it. One of my sister's pension fund's advantages is that I don't over-manage it. She is lucky if I do it twice a year, or once a year is more normal.”

Warren Buffett:

By the way Buffett does not use “earnings” to value stocks but free cash flow and it is also “normalized” to an extent via capital expenditures and the such, but thats not relevant to out debate. Buffett penned an article a long time ago discussing ROE and its fluctuation. Obviously he was making the point that companies with Durable Competitive Advantage tend to have above average ROE for a long time. Implicit in his conversation he described the reversion of ROE back to average as companies compete within this we find a silent affirmation of the reversion of margins within specific companies. Obviously this can be applied to great majority of the market…But on this i can only assume

Benjamin Graham:

From the Intelligent Investor(Zwieg 2003 edition) “On the whole it may be better for the investor to do his stock buying whenever he has money to put into stocks, EXCEPT when the general market level is much higher than can be justified by well established standards of value” In full disclosure the next sentence says:

“If he wants to be shrewd he can look for the ever present bargain opportunities in individual securities”


Here is a specific commentary by John Hussman on the use of the peak-earnings valuation methodology (which is comparable with Shiller's CAPE methodology):


The graph about a page down demonstrates the historical accuracy of the model. Also, to color your point about a certain CAPE ratio implying a certain degree of falling earnings, you are falling into your own intellectual trap where you assume that the reversion is going to take place overnight. Neither Shiller nor Hussman come to this conclusion with their own methodologies. Rather, they recognize that high valuations mean that long-term returns are stretched low and risk (drawdown) is stretched high. It might mean 10-year returns of 4% instead of 10%. See Hussman's notes on Shiller's methodology in the table on this commentary:


The one thing I would agree with wholeheartedly is that high valuations call for much higher selectivity in individual stock selection.

To paraphrase someone earlier in the comments:

2.These market illuminati for the most part are also backing what they say..note their allocations in the past and now:

As for Grantham I looked at his fund and low and behold he has minimal equity allocation…obviously he eats his own cooking having stock allocations at minimal.

Charles Munger 2002-2008 was only in US treasuries when Buffetts GDP/Marekt cap ratio near 100 he is known to be able to go on years without investing patience is indeed a virtue. Where did I find this gem of information? Munger ran the investment portfolio for a small cap newspaper company. Once again Shiller PE10 and TobinQ were a practical and correct answer to market valuation

Robert Rodriguez-I can’t find the specific letter but he said in 2011 based on margins…he would be all cash if possible. His colleague Steven romick, has also stated the influence of mean revering profit margins in a recent conversation with Gurufocus. I can provide the exact hyperlink if need be.

Buffett is particularly interesting. In his famous 2008 Op-ed “Buy American I am” he stated that previously he was all cash/treasury like his partner Munger. And this was in their personal accounts. Not only did his own market valuation method (GDP to market cap) state stock were expensive but did not buy stocks until it had dropped below the level they are now(where the market is supposedly “fair”). Interestingly the Shiller PE was at that time around its long term average of 15-16, now its level is at 21-22. This seems to suipport his own GPD/Market Cap ratio.

And to be honest I get somewhat irritated, few are the analyst or financial advisors who will never tell you not to invest. Why would they? It’s their living. The financial media, the majority of Wall Street has a built in incentive to provide a bullish slant.

I believe you yourself wrote a critique of the Shiller PE a few months ago, and this one also lit a bit of controversy. I invite readers to look at the comments there as well; they will prove a most enlightening experience.


My hope is to at least provide readers with a contesting point of view for other measures of value not touted by the financial media. Hopefully, they can make a decision on their own and reach their own conclusion. In my humble opinion and based on the preponderance of evidence, I must conclude that although individual stocks are fair or even undervalued, the SP 500 when taken in its historical context is not fairly valued.

Jonmonsea premium member - 5 years ago
I laud the previous commenter's thoroughness and would only add the following. 1. Joel Greenblatt has said that the cheaper parts of the market (high earnings yield+high ROIC) are set to return satisfactorily, and he gave HPQ as an example of overreaction. We'll have to see if he's right obviously. But, I think he is.

2. Permabulls or patriots or whatever one might want to call them could well be right that nominal returns stay in the some ole' range as post-Carter to Post-Clinton, but after-inflation, after expense returns seem very unlikely to match the great bull run's. Didn't Munger comment once that if you fo inflation plus 100bps you're doing very well?

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pbarker46Total Payout Yield
DBrizanrota16Jan2018 1143p
DBrizanrota16Jan2018 1118p
DBrizanrota16Jan2018 1114p
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