Stocks: Price, Valuation and the Bull Market

Written by: Global Thought Leadership | August 24, 2018

Source: Bloomberg, August 23, 2018. 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

  • This week, according to most accounts, stocks broke through the record for the longest bull market in history, rising for some 2,383 trading days without a 20% bear-market break.[1]
  • During that time, the S&P 500 Index rose over 320% -- a 16.5% annualized rate. Including reinvested dividends, the rise was nearly 410%, an annualized 18.8%.
  • But the real—if unanswerable—question behind these mind-boggling numbers is whether this strong market will continue to break records.
  • For fundamentals-based investors, a key indicator is valuation – whether stocks are worth what the market is currently paying for them.
  • In terms of earnings expectations, stock valuations don’t appear to be overly expensive, trading at a P/E[2] of 17.7 times next year’s forward (estimated) earnings.
  • That’s somewhat higher than the average forward P/E of about 16.9, but a far cry from the high of 26.9 reached during the heights of the valuation peak of the Tech Bubble of  1998-2000.
  • More notably, earnings expectations have risen in light of strong company earnings, driving the P/E down to about 17.7 – making the S&P 500 more potentially attractive as the year has progressed.
  • The bottom line: At this point, stock valuations don’t appear to be excessive by historical measures; as knowledgeable, fundamentals-based active investors know, value can be very different from price.

[1] “Bull market” is a general term referring to a securities market that is rising, often by 20% or more, without a significant pullback of 20%.  A “bear market” refers to a market that has dropped by 20% or more without a significant upward move. March 9, 2008 – Aug 23, 2018 is often referred to as a bull market.

[2] The price- earnings (P/E) ratio is a stock's (or index’s) price divided by its earnings per share (or index earnings). The forward P/E ratio is a stock’s (or index’s) current price divided by its estimated earnings per share (or estimated index earnings), usually one-year ahead.


Definitions:

The S&P 500 Index is an unmanaged index of 500 stocks that is generally representative of the performance of larger companies in the U.S.

The price- earnings (P/E) ratio is a stock's (or index’s) price divided by its earnings per share (or index earnings). The forward P/E ratio is a stock’s (or index’s) current price divided by its estimated earnings per share (or estimated index earnings), usually one-year ahead.

Valuation refers to measures of a security’s price in term of its underlying company’s fundamentals, such as earnings per share, sales, book value, growth rate, etc.

 

 

Top

Forecasts are inherently limited and should not be relied upon as indicators of actual or future performance.

Active management does not ensure gains or protect against market declines.

IMPORTANT INFORMATION: All investments involve risk, including loss of principal. Past performance is no guarantee of future results. An investor cannot invest directly in an index. Unmanaged index returns do not reflect any fees, expenses or sales charges.

Equity securities are subject to price fluctuation and possible loss of principal. Fixed-income securities involve interest rate, credit, inflation and reinvestment risks; and possible loss of principal. As interest rates rise, the value of fixed income securities falls. International investments are subject to special risks including currency fluctuations, social, economic and political uncertainties, which could increase volatility. These risks are magnified in emerging markets.

The opinions and views expressed herein are not intended to be relied upon as a prediction or forecast of actual future events or performance, guarantee of future results, recommendations or advice.  Statements made in this material are not intended as buy or sell recommendations of any securities. Forward-looking statements are subject to uncertainties that could cause actual developments and results to differ materially from the expectations expressed. This information has been prepared from sources believed reliable but the accuracy and completeness of the information cannot be guaranteed. Information and opinions expressed by either Legg Mason or its affiliates are current as at the date indicated, are subject to change without notice, and do not  take into account the particular investment objectives, financial situation or needs of individual investors.