Just because something goes up fast, why does that means it is overvalued? Some Friday thoughts…
It is an important questions simply because I am getting asked it a lot. “The S&P is up > 60% from its low just over a year ago, after that run it must be “pricey”, no?” they ask.
Well, that depends on whether or not you considered S&P 683 on March 6,2009 a accurate valuation. If you think that was an extreme over reaction to the downside (it was) then the 60%+ plus run in the S&P has to be put into context. How much of that appreciation was simply value catch up meaning to indexes were just returning to a more “fair value” after the fear subsided? IMO, most of it.
If that is true, then where do we stand now?
Operating earnings for the S&P for the coming year are estimated to be roughly $80 (up from $78 after latest results). Based on that recent slate of earnings, that very well may prove to be too low, but we’ll go with it. At S&P 1200, that gives us a 15 earnings multiple for the S&P. Since 1988, the S&P has carried an ~19 multiple and if we take out the 1998-2000 tech bubble years, it falls to ~18.
Meaning??? The S&P, at 1200, IMO is far from being “overvalued”. The argument instead is between “fair” and “under” and that depends on your view of S&P earnings for the rest of the year and into next.
Now, this is NOT a market call to say that “it is going higher”. That is not my thing. I will admit right now I have no idea where the market is going today or tomorrow. The 70’s proved markets can stay below reasonable values for some time. It does mean however that we are not running into an area where valuations in general are getting ahead of themselves.
Of course if 2nd half earnings fall, then the $80 expected now might be an optimistic number. That being said, they would have to fall to $66 for our discussion to change parameters. I have not seen too many what I think are credible analysis’ that call for a significant decline in 2nd half 2010 earnings. Those all seem to require a significant shock to the system to achieve. Assuming we do not get one, they lose their teeth. Assuming we avoid that shock, the trend is up for the rest of the year.
When discussing cheap or expensive in the context of a 30% rise or fall in the price of something, where you start is more important that where you are ending at. If you own shares in a good company trading for simply the value of its cash in the bank, a 30% rise in the stock in no way makes it expensive. Conversely a company trading at 100x earnings that sees a 30% price fall isn’t suddenly cheap, its just less expensive at 70x and that is a significant difference.
Price and value are two different things. If I have stock “a” to sell you for $1 and tomorrow the price is $2, do you not buy it if you think it is worth $6? After all, the price has run 100%, right?