The Dow Jones Industrial Average and the S&P 500 both
achieved new highs for 2009 yesterday. As my colleague Morgan
Housel wrote last Friday,
optimism is back! Splendid news for stock investors,
indeed … or not. Would it surprise you to
learn that it is much riskier to buy U.S. stocks now than it
was at the beginning of March, when fear and panic were at
theirhighs?
It comes down to valuation (as always)
The reason? Price. At yesterday's closing value of
1,028, the S&P 500 is trading at 18.4 times its
cyclically-adjusted earnings (average inflation-adjusted
earnings over the prior 10 years). That is a 12% premium to
the multiple's long-term average going back nearly 130
years.
The cyclically-adjusted P/E ratio -- or CAPE -- was
originally pioneered by investing legend Ben Graham. It is
one of the only indicators that has consistently proved its
worth in identifying whether the U.S. stock market is
significantly over- or undervalued.
Why pay a premium now?
Under normal circumstances, a 12% premium wouldn't
really be troublesome. However, when one factors in the
(high) likelihood of a protracted, weak economic recovery,
any premium is problematic. By contrast, on March 9th, the
date on which the stock market hit its crisis low, one could
have "purchased" the S&P 500 for just 11.8 times
cyclically-adjusted earnings -- a 28% discount to the
long-term average. (For the skeptics: One could have derived
this figure at the time -- the CAPE isn't just useful in
hindsight.)
The increase in the earnings multiple is even more
striking for some individual stocks (these one-year forward
earnings multiples must be
treated with caution-- they do not necessarily imply that
any of these stocks are overvalued):
Stock
Forward P/E (Next
12 Months EPS Estimate)
Forward P/E on
March 9, 2009
% Stock Price Return
Since March 9 Market Low
JPMorgan Chase
(NYSE: JPM)
18.8
9.6
174%
Apple
(Nasdaq: AAPL)
26.1
16.5
104%
General Electric
(NYSE: GE)
18.0
6.0
93%
Microsoft
(Nasdaq: MSFT)
14.3
8.5
63%
Cisco Systems
(Nasdaq: CSCO) Continued... |