Are Stocks Cheap or Expensive? How to Tell

March 8, 2015 11:00am by

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This morning in my Sunday Washington Post Business Section column, we look at the issue of how expensive U.S. stocks are. There are several ways to determine this, fraught with the potential for error.

If you want to determine how cheap or expensive the stock market is,  I suggest three commandments to consider:

●Thou shalt consider a full assortment of all valuation metrics;

●Thou shalt not cherry-pick only those metrics that support your preferred outcome;

●Thou shalt focus on the very best measure of market valuation, according to academic research and data.

The column goes on to explain each of those factors in detail. Here’s an excerpt:

“Anyone can point to a single metric that shows stocks as either cheap or expensive.

Those who are bearish usually go for Trailing Price to Earnings ratio (17.1 P/E), which shows stocks as pricey, or the even more expensive Shiller’s Cyclically Adjusted PE, which show stocks as very pricey (26.8 CAPE).

Conversely, those who are bullish choose other metrics: They select price to free cash flow or price to normalized earnings to show markets as cheap. The Standard & Poor’s 500-stock index is valued at 22.3 times free cash flow — about 22 percent below its average reading from 1986 to 2014. Price to normalized earnings is at 18.6 times, or 2 percent less than its post-September 1987 average.”

Of course, the point is that you don’t pick the metric that supports your conclusion rather, you look at ALL the metrics in order to get a better sense of valuation.

And, looking at the metric with the vert best track record of indicating future returns is never a bad idea, either.

 

 

Source:
Many metrics can be used to value markets. Which should you trust?
Barry Ritholtz
Washington Post, March 8, 2015 2015
http://wapo.st/1AT11ss

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Discussions found on the web:
  1. klhoughton commented on Mar 8

    Normalized earnings are like EBITDA, right? The money the company would be making if management didn’t exist to have hamstrung it will illegal activities and/or a debt load the size of Patagonia?

  2. VennData commented on Mar 8

    We’ll find out in a year or two if stocks are expensive right now.

  3. bmz commented on Mar 9

    The variable with the greatest impact on stock price: the discount rate– is extraordinarily low now. Hence, stock prices are indisputably low now.

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