Yes, I must listen to financial media. No, I don’t have to like it.
My dislike stems from the use of quick headlines to stir the pot. Recently, discussions around ‘valuations’ have been my main pet peeve.
Many are talking about how ‘overvalued’ the S&P 500 index is even now. And that if we enter a recession the index must trade lower by leaps and bounds. Anything is possible. But let’s break it down a bit. According to Ycharts.com, the forecasted S&P 500 price earnings (P/E) multiple is 17. In this case, the current price of the index is divided by the total forecasted earnings of each S&P company for 2023. This represents an earnings yield of approximately 5.9%. You get the
earnings yield by dividing a hypothetical $1 of earnings by the P/E ratio – in this case 1 over 17. When comparing this to a 10-year treasury yield of, let’s say, 4% you don’t seem to be getting a lot more of a reward for taking the risk in stocks (4% vs 5.9%). So maybe the S&P 500 index is overvalued? Not so fast.
Let’s dig a bit deeper. Did you know that the top 10 stocks of the S&P represent almost 26% of the index? These companies – Amazon, Tesla, Apple, etc. – have an average P/E of 35. Yikes. Of course, these are some of the best companies around, but they aren’t cheap.
What if we removed these top 10 stocks from our equation to see what the average P/E was for the remaining 490 companies? Lo and behold, the P/E turns out to be around 11. That’s a lot cheaper than the index P/E of 17, and certainly cheaper than the 35 P/E of the top ten companies. Now of course it doesn’t mean that each of those 490 remaining stocks
are reasonably priced, but it does mean that if you pick through the index, you can find a lot of stocks with good earnings at reasonable prices. I have found several stocks under a P/E of 10. Just a quick lesson. When you hear someone blurt out the terms “overvalued” or “overpriced,” don’t settle for their interpretation.
The opinions expressed in this commentary are those of the author and may not necessarily reflect those held Twin Gryphon Advisors, LLC. This is for general information only and is not intended to provide specific investment advice or recommendations for any individual. It is suggested that you consult your financial professional, attorney, or tax advisor with regard to your individual situation. Comments concerning the past performance are not intended to be forward-looking and should not be viewed as an indication of future results. Investment advisory services offered through Twin Gryphon Advisors, LLC, a registered investment advisor. The material is for informational purposes only. It represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events or a guarantee of future results. It does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor. Neither the information presented, nor any opinion expressed, constitutes a solicitation for the purchase or sale of any security. Past performance does not guarantee future results.