Are Stocks Overvalued?

If you want a more negative argument on stock market valuation go read in yesterday's Wall Street Journal the article titled "Are Stocks Overvalued?  Depends on the Metric."   Here's the main point:

"Now that traders increasingly believe the Federal Reserve will raise rates later this year, there is a renewed focus on valuations.

The price-to-earnings ratio on the S&P 500, currently around 18.25, is modestly high. Robert Schiller’s CAPE ratio, which focused on earnings for the past decade, indicates valuations are at dot-com level highs. But Mr. Schiller’s measure may be misleading, given changes in accounting rules that pushed down earnings. Of course, companies can push up earnings even when sales are flat, either through cost cutting or stock buybacks.

Sales growth, some argue, provides a cleaner view into a company’s health, and there are a number of valuation measures using sales that they point to, including price-to-sales, market cap-to-sales, enterprise value-to-EBIDTA, and more.

Ominously, all of them are at more distressing levels than a standard PE ratio.

The market cap-to-sales currently sits around 1.84, according to data from Yardeni Research, a level not seen since the dot-com boom, when it peaked at 2. The measure typically signals stocks are overvalued when they are at one or higher, according to Vincent Lowry of OppenheimerFunds.

Similarly, the price-to-sales ratio on the S&P 500, currently at 1.90, is higher than it has been at any point since February 2001.

In his opus, “What Works on Wall Street,” James O’Shaughnessy argues stocks with low price/sales ratios beat the broader market, but that the single best metric for measuring stock returns is the ratio of enterprise value/EBIDTA (earnings before interest, depreciation, taxes and amortization).The S&P 500′s EV/EBIDTA ratio currently sits at 11.77. It has not been that high since 2002, when it was on its way down from the dot-com heights.

This doesn’t necessarily mean a crash is coming, but it does illustrate in myriad ways that the market is richly valued, and in essence, investors are betting that everything from here on out is going to go perfectly, that profits will grow, wages will rise, and the economy will take off."

*Long ETFs related to the S&P 500 in client and personal accounts.  Please note that positions can change at any time without notice on this blog or in printed or in electronic media.