I am interested in the right numbers.
Dismissing price/GDP might be correct or not. We don’t buy shares in GDP.
It doesn’t mean that GDP is completely irrelevant though. I use price to actual sales and net margins on actual sales to judge valuation and profitability.
So dismissing market cap/GDP is not a victory for me like for Macroman.
There are many factors that go into determining profit margins for companies and indexes composed of many companies. In fact, I will bet you don’t know there are 3 different ways to calculate the P/E ratio of a 10 stock portfolio and which one Standard and Poors uses. And then there can be significant differences between the Index, its cap weighted P/E, its summed P/E, its equal weighted P/E and its median P/E. These can vary greatly and deliver very mixed messages.
I look at all of them just to be sure.
In 1999, the measured P/E of the S&P 500 at the top was around 25x’s forward EPS. However, 50 names in it, comprising 50% of its market cap traded for 40x’s EPS. The other 450 names and 50% of cap traded at 10x’s (ballpark numbers). So the Index traded at 25x’s when all the stocks were either 40x’s or 10 x’s. P/E ratios were bimodal with an small expensive group, the TMT bubble, and a large group of old economy cheap stocks.
2007 was very different with the average stock trading much higher than the index one. The S&P 500 mega caps at 10-12 pulled down the average multiple from a 20 P/E level for the median stock.
Today we are much closer to 2007. With slow growth, mega caps at 12x’s like XOM, CVX, WMT, BAC, JPM, C, GE, etc pulling down the 500 stock conglomerate P/E ratio when the median P/E in the S&P 500 is closer to 17.5. The smaller cap indexes are 18-20x’s and the broader index is around 19.
So don’t tell me the market is cheap at 14x’s 2014 non GAAP top down S&P 500 estimates. NO ONE HAS A PORTFOLIO P/E THAT LOW.
We might be justified expensive w low rates and inflation. But we are not cheap. And the real P/E ratios out there do not reflect reality of how the P/E is calculated. Summing market caps and profits, ie. the subsidiary model, which is what Standard and Poors does I believe, isn’t a great indicator of average stock P/E ratios, just like they weren’t in 1999 or 2007.
Got all that my friend?
See that everyday or not? I don’t know how sophisticated investors challenge both the data and the process behind calculating the numbers but I try and understand the gist of the valuation argument.
And it remains: stocks in general have high P/E ratios multiplying high profit margins for high price/sales ratios. These PSR levels for the median stock or the average stock is at an all time record! Higher than 2000 or 2007. Now, sub-segments of the market have had even higher valuations in the recent past and stock valuation certainly can climb more.
But don’t dare make the case that stocks are cheap.
There’s also the VL median P/E at 19x’s when 20 never breached in past 50 years. And the VL median appreciation potential, which is a 3-5yr earnings discount model calculated for each company in universe using some form of normalized margins. It shows 30% upside, a 50 year low (ie. record high valuations vs. growth potential). Hope I made a good case for high valuations, though I can’t guarantee stocks are at a top. What I learned short yahoo in 1997 is that valuations can ALWAYS go higher than anyone imagines.
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