Stock valuation: How hot is the engine?

Written by: Global Thought Leadership | August 18, 2017
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Source: Bloomberg, as of 8/11/2017. Past performance is no guarantee of future results. Indexes are unmanaged, and not available for direct investment. Index returns do not include fees or sales charges. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.

The Bottom Line

  • Major U.S. stock indexes have fairly rich valuations relative to their long-term norms. Should investors be concerned?
  • It’s the kind of question that demands a view of the markets which goes beyond topline figures, since stocks today are anything but monolithic.
  • Consider the S&P 500.On a forward price-to-earnings (P/E) basis (comparing the current price to expected earnings a year from now)—the overall index trades at a multiple around 19x as of 8/11/2017.1
  • That’s elevated by historical standards. Yet almost 300 companies included in the index had forward P/Es lower than that. Of these, 178 sported P/Es below 15x next year’s earnings.
  • To be fair, not all these lower P/E companies will ultimately delight investors—some stocks have low valuations for good reason:  poor future earnings potential.
  • But when low valuations don’t correctly reflect future earnings, there’s potential for price appreciation.
  • Parsing the factors that can help identify mispricing at any level is central to active strategies that seek the most attractive—and avoid the least attractive—investment options. Passive investors, of course, must be willing to accept owning both. 

1 Source for all data is Bloomberg. As of 8/11/2017, the forward P/E of the S&P 500 as 18.9x based on Bloomberg’s estimate for the next year’s earnings of each constituent member.

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