The Stock Market is Fairly Valued
Many have argued for quite some time that the stock market is overvalued and long overdue for a correction. While it may be true that the stock market recovery has significantly outpaced the economic recovery since the most recent stock market crash hit bottom in March of 2009, the stock market currently appears to be fairly valued from a historical perspective. It is even fair to say that the most recent pullback that took place over the course of the last volatile week in the stock market has made the market (as defined by the S&P 500 index) even more fairly valued and perhaps even more attractive to stock market investors who believe that we are in the midst of a secular bull market with more room to run.
Using data from Bloomberg, we analyzed the historical P/E and Price/Book Value ratios of the S&P 500 index (S&P 500) over the course of the past 25 years. To clarify, P/E is a ratio of the price of a stock and the company’s earnings per share while Price/Book Value is a ratio of the stock price to the book value per share. For these purposes, current stock prices were used for both ratios and trailing twelve month earnings per share data were used for the P/E ratios. Book values per share were determined by dividing total common equity by the number of shares outstanding.
What we found is that since December 31, 1990, the average P/E ratio of the S&P 500 is 19.72. Currently, the P/E ratio of the S&P 500 is 17.55. This represents an 11% discount to the longer run average.
Even if one looks back further, the market is still trading at a relatively fair valuation. Using the same Bloomberg data going back to December 31, 1978, the average P/E ratio of the S&P 500 is 17.12. Hence, the current P/E ratio of 17.55 represents just a 2.5% premium to this even longer term average.
Some investors put more stock (pun intended) in the Price/Book Value ratio than the P/E ratio when assessing the valuation of stocks or the stock market as a whole. As a result, we conducted our same historical review of Bloomberg data for the S&P 500, for the same time period, and reached a similar conclusion. The average Price/Book Value ratio of the S&P 500 for the period December 1990 – August 2015 is 2.87. The current Price/Book Value ratio of the S&P 500 as of August 28, 2015 is 2.68. This represents a 6.8% discount to this 25 year average.
By providing this analysis of historical stock market valuations, we are not suggesting that the days of market volatility are behind us now nor are we suggesting that there will not be more pullbacks in the market in the days and weeks to come. To the contrary, we are providing this analysis to help provide some historical context to the widely held contention in the industry that the “market is overvalued”.
Valuations aside, we, at Hennion & Walsh, believe that building and managing a diversified growth portfolio with a longer term perspective that includes asset classes, geographies and sectors of the market that are not perfectly correlated with U.S. Large Cap Stocks (i.e. “the market”) is critical as we move forward in the next phase of this secular bull market cycle.
Disclosure: The Standard & Poor’s (S&P) 500 Index is an unmanaged index that tracks the performance of 500 widely held, large-capitalization U.S. stocks. Indices are not managed and do not incur fees or expenses. It is not possible to invest directly in an index. The overview above is for informational purposes and is not an offer to sell or a solicitation of an offer to buy any of the themes discussed.