Wall Street had a reality check today as the S&P 500 dropped 1.46% and the Nasdaq fell 2.37% as durable goods orders showed an unexpected drop. Technology, namely semi-conductors and biotech both took a big 4-5% haircut almost across the board today.
Is the stock market currently overvalued, undervalued, or fairly valued? After today's declines we recap six historically relevant market valuation predictors and where they stand in the current market environment (S&P 500) and whether they indicate the market as being over, under, or fairly valued.
This isn't a be-all-end-all barometer to buying or selling stocks, but these are key data indicators that help provide a money managers an optimal time to enter the market...or suggest holding off or reducing the amount invested until better overall market conditions prevail.
The six measures we will be considering are: P/E Ratio, CAPE Ratio, Dividend Yield, Price/Book Ratio, Price/Sales Ratio, and Q-Ratio (see the appendix for definitions):
Is the stock market overvalued? Report for March 25, 2015
P/E Ratio - 19.45 - FAIR
CAPE Ratio - 27.08 - OVERVALUED
Dividend Yield - 1.91% - OVERVALUED
Price/Book Ratio - 2.80 - FAIR
Price/Sales Ratio - 1.78 - OVERVALUED
Tobin's Q-Ratio - 1.15 - OVERVALUED
As of March 25, 2015, four of the six market value predictors are in overvalued territory.
P/E Ratio (price-to-earnings ratio) - is the total price of the market divided by the total earnings (latest reported) of the companies. Since 1870, this has ranged from a low of 5.31 in December of 1971 to a peak of 123.73 in May 2009 and averaged 15.53.
CAPE Ratio (Shiller's PE) - is the total price of the market to the average inflation-adjusted earnings (previous 10 years). Since 1870, this has ranged between 4.78 in December of 1920 to 44.19 in December of 1999
Dividend Yield - is the combined 12-month dividend per share of the total market divided by the total price of the market. Since 1870, this have averaged 4.41% with a range of 1.1% in August 2000 and 13.84% in June 1932.
Price/Book Ratio - is the total price of the market divided by the estimated book value of the companies. Since 2000, this had ranged from 1.78 in March 2009 to 5.06 in March 2000 with an average of 2.74.
Price/Sales Ratio - is the total price of the market divided by the total revenue of the companies. Since 2000, this has ranged from 0.8 in March of 2009 to 1.78 of March of 2015 with an average of 1.39.
Tobin's Q-Ratio - is the total price of the market divided by the replacement cost of all its companies. The replacement cost of the companies is determined by the Federal Reserve. Through history, the Q-Ratio has averaged around 0.68 with all-time lows (around 0.30) coming in 1921, 1932, and 1982 and an all-time high of 1.64 coming in 2000 around the tech-bubble.