You don't have to look to far to find some pundits indicating that we're due for a major stock market correction as the prices of many stocks have approached or even surpassed their 2007 highs. You can click this article on Forbes to see Scott Redler comment that the market is approaching new highs, or you can click on this article on CNBC titled "Why This Market Correction May Have A Way To Go" to get another glimpse into the emerging conventional wisdom that stocks are overdue for a pullback. While I offer no predictions on what the stock market will do this year or next, I do want to use this opportunity to object to the notion that new market highs are automatic indicators of overvaluation, and somehow denote that investors should start trimming their positions.
Because talking about the market highs for indices such as the S&P 500 or The Dow Jones is too abstract and vague to illustrate the point, I decided to use seven examples from the Dow Jones 30 Index to demonstrate the fact that higher stock prices do not automatically indicate that a company is overvalued. Since approaching and moving past the 2007 market highs are on the minds of many, I thought I would point you to seven examples of companies that have higher stock prices now than in 2007, yet appear cheaper today on a P/E basis, assuming all else is equal.
Take a look at these data comparisons that I have compiled:
1. In 2007, 3M (MMM) traded at a high of $97.00 while earning $5.60 per share. That is a P/E ratio of 17.32. Today, 3M trades at $102 relative to $6.32 in earnings. That is a P/E ratio of 16.13.
2. In 2007, Chevron (CVX) hit a high of $95.50 while earning $8.77 per share. That is a P/E ratio of 10.88. Today, Chevron trades at $115 relative to $13.32 in earnings. That is a P/E ratio of 8.63.
3. In 2007, IBM (IBM) traded at a high of $121.50 while earning $7.18 per share. That is a P/E ratio of 16.92. Today, IBM trades at $201 per share, noticeably higher than the company's high in 2007. Yet, IBM now generates $14.41 per share in earnings. That is a P/E ratio of 13.94.
4. In 2007, McDonalds (MCD) hit a high of $63.70 while earning $2.91 per share. That is a P/E ratio of 21.89. Today, McDonalds trades at $95 per share relative to $5.36 in earnings. That is a P/E ratio of 17.72.
5. In 2007, Procter & Gamble (PG) hit a high of $75.20 while earning $3.04 per share. That is a P/E ratio of 24.73. Today, lo and behold, Procter & Gamble trades at the exact same price. Yet, guess what, instead of $3.04 in earnings, shares of the stock now represent $3.90 in earnings. That is a P/E ratio of 19.28.
6. In 2007, Coca-Cola (KO) hit a split-adjusted high of $32.20 while earning $1.29 per share. That is a P/E ratio of 24.96. Today, the company is trading at $38.77 while generating earnings of $1.92 per share. That is a P/E ratio of 20.19.
7. In 2007, Wal-Mart (WMT) hit a high of $51.40 while earning $3.16 per share. That is a P/E ratio of 16.26. Today, the company is trading noticeably higher at $71.50, yet the company is now generating $4.86 in earnings. That is a P/E ratio of 14.71.
While these businesses run the gamut from selling post-it notes to oil, hamburgers to technology services, and bleach to soft drinks, they all share two characteristics in common:
(1) All of these companies are currently trading at a higher price than their 2007 highs.
(2) From a P/E standpoint, all of these companies are trading at a cheaper valuation than they did in 2007.
That is why I don't get hung up on all the noise about "52 week highs" and headlines that scream that "2013 Prices are Higher Than 2007 Prices." Yes, the prices are higher, but the earnings are also higher. What I find most interesting is that, over the past five years, we have witnessed arguably the third-worst economic collapse of the past one hundred years (with the Great Depression, and the 1973-1974 collapse being demonstrably worse), yet all seven of these companies have managed to grow earnings at such a rate that their stock prices are higher than they were at the 2007 top, yet the current valuations suggest that they might be cheaper than they were in 2007.
It is the relationship between stock price, current earnings, and future earnings that determine overvaluation, fair valuation, or undervaluation. Instead of worrying about the headlines and the performance of the stock indices in general, look to your individual stock selections and take a hard look at the current earnings (as well as your projections for future earnings) to get a handle on whether you think now is the time to trim positions. If you follow the media's lead in using 2007 as a reference point, you might find that your stocks are cheaper than you might think, despite the current market highs.