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The stock market continues to race higher and nothing seems to matter. But with every tick higher, valuations continue to get stretched to the upside. Just as a quick review, history shows us that, valuations are highly subjective and overvalued markets can easily get a lot more overvalued before the bull market finally ends.
3 Popular Ways To Measure Valuation:
Here are three popular ways to measure value: Most people use the trailing 12 month price-to-earnings ratio (P/E ratio) to determine value. Other investors prefer to use the forward 12 month P/E ratio (which looks at forward earnings). A third popular way investors use to measure value is to look at the price to sales ratio. The basic premise of these three metrics is to look at the current market price and see how that compares to a well-known measure such as: sales and/or earnings. For the purposes of this article, I will be using the trailing twelve month (TTM) price to earnings (P/E) ratio.
Fairly Valued Or Overvalued? That Is The Question?
Historically, the S&P 500’s mean P/E ratio is around 15. Currently, it in the mid-20’s. The last two times the S&P 500’s P/E ratio hit the mid to upper 20’s was in the late 1920’s and the late 1990’s, and we all know what happened shortly thereafter. That doesn’t mean the market crashes tomorrow, it just shows you what happened in the past when valuations were this high. It is important to note that history does show us that market valuations can continue to get stretched for quite some time before the bull market eventually ends. Some argue that the market is fairly valued at these levels and some argue that it is overvalued. I decided to asked a few portfolio managers what they think and here is what they told me:
What The Pros Are Saying:
David Ott, Partner, at Acropolis Investment Management, with $1.5 billion under management told me, “Naturally, the market’s high valuation is a concern, but it’s my view that it’s been overvalued for about three years. Over that time period, the S&P 500 has gone up 30 percent, which goes to show you that you really can’t time the market with any kind of precision using valuation. The data clearly shows that valuation impacts future returns, but not enough, in our view, to make timing decisions. I do believe that valuation does provide some sense of future expected returns and that today’s higher than average valuations probably mean lower than average returns in the coming years. But again, you could have said the same thing three years ago and still enjoyed strong results since then.”