Going out 12 months, we calculate the stock market currently has a forward P/E ratio of 14.3. The historic average over the last 30 years, a period when we had an economy similar to what we have now, is around 16.0.
From a pure valuation standpoint, the current reading indicates the S&P 500 is undervalued by around 10%. This means that even if there is no growth in earnings, we can get a +10% rise in stocks based on valuation alone. A dividend discount model run on the component stocks within the Dow Jones Industrial Average also indicates an undervalued market.
Another way to look at this valuation is to flip the P/E ratio into an earnings yield. Then, this ratio can be viewed in a similar fashion to the yield on a bond. The current S&P 500 earnings yield is around 7%. Based on historical levels, given current interest rates, the earnings yield of the market should be around 5%. This is a clear indication that stocks remain cheap relative to bonds
This earnings season large company earnings have been growing at +2.8% annually and revenues have been growing at +0.9%. If we take the position of thinking in GDP terms, then these big companies are underperforming the GDP growth rate of +2% to +2.5%.
In other words, we are not seeing strong big company earnings growth right now. This is the second lowest earnings growth rate seen since 2009. Overall, earnings growth has not been that strong. This is a negative for the market.
Then why is the market at all time highs? When there is a negative consensus on something, the market tends to climb that wall of worry. This is exactly what we have seen over the last three and a half years.
If earnings growth was too strong, then it might actually mean this market has become frothy. In an odd way, the weak numbers are actually good for the market. They show that there is even more upside because as they eventually pick-up, this will be an additional benefit to the market that is not yet priced in
I just can't see where stocks that are showing little or no EPS growth are worth a 16 P/E. Most of the little growth that S+P 500 type stocks have shown in the last few years has been from cost cutting and not revenue growth. Just look at a few "leaders" like JNJ, VZ, PG, and K. The only thing going for them is dividend growth. I'd like to own any one of them as a company, but not at recent valuations.
For the most part I agree with that statement. I would not buy a largecap showing 1% revenue growth with a pe above 12. Why 12?
I like the number 12, and my nephew just renamed himself Twelve. He is autistic and seven years old.
Zacks as a company is bullish right now and looking for reasonable support to the thesis that the market is not overvalued. We are approaching all time highs not seen for five years. Lots of value has been added during the recovery from the 08 crash, that when factored in, will justify current valuations. Yeah, some are and some are not, but on average the market is not overvalued.