One of the most important advantages that we as investors have is the ability to evaluate each of our holdings on an individual basis. When someone points out that the Dow Jones or S&P 500 Index has reached a new high, we can respond by recognizing that those statistics reflect a blended average and we can proceed to evaluate each stock individually to determine whether the high is justified by profits or not.
On May 16, Bank of America (BAC) reached a new high when it crossed the $13.55 mark. That is not necessarily something to worry about when viewed through the lens of tangible book value. Bank of America has about $20.24 of total book value. About $7.60 of it counts as intangible book value. That gives us a tangible book value figure of $12.64. Oftentimes, it can be a signal that a bank is fairly valued (or, in some cases, moderately undervalued) when it is trading in the vicinity of its tangible book value. The fact that Bank of America has reached an annual high should not worry investors because it represents Bank of America's progress toward toward fair valuation.
In the case of Chevron (CVX), the company currently trades at $124.72. That is very close to the high reached last week at $125.00. But here's the thing. The company is earning $13.23 per share. That gives you a P/E ratio below 10, and that has historically indicated fair valuation for Chevron during periods of stable commodity prices. Absent a significant decline in energy pricing, there is no need to worry about Chevron's price because the rising share price has matched Chevron's 15.0% annual growth in earnings over the past decade.
With General Electric (GE) climbing to $23.54 (flirting with its March high of $23.90), it could lead some to believe that the company is overvalued. But still, the company trades at 16.40x earnings. Even when you manually strip out the high P/E ratios during the dotcom bubble years and adjust for normalized earnings, you can find plenty of years when GE typically traded at 16-18x earnings. Considering that GE Capital is only using one-fourth of the leverage it used in 2007 before the financial crisis, and considering that the company is scaling back its vast real estate portfolio while diverting future profits towards taking a bite out of the $200 billion backlog, it seems reasonable to argue that the company is fairly valued despite flirting with new highs (especially when you take into account the high quality of current earnings).
Depending on how you choose to account for non-recurring items in Hershey's earnings, the company has current earnings power of between $3.08 per share and $3.24 per share. The company currently trades at $88.80 per share. That is a P/E ratio of between 27.40x earnings and 28.83x earnings. I find that troubling because during the dotcom bubble years, Hershey traded at a P/E ratio of between 26-29x earnings. That is partially why I consider the current valuation a troubling sign for long-term investors looking to initiate a position at these levels. In 2005, Hershey traded at 25x earnings. That is the only other modern time when Hershey's valuation approached this kind of richness.
Likewise, on May 16, Brown Forman hit a high of $74.29 per share. I found that high to be troubling because that means that the company is currently trading at 26-27x earnings. Looking at data going back to 1997, Brown Forman never traded above 22.5x earnings during the 1997-2011 stretch. Most years, it has a P/E ratio below 20. I would hesitate to buy Brown Forman at today's prices because there has been no point in the past sixteen years in which Brown Forman was this expensive. When a large-cap stock trades at its highest valuation looking back to almost a generation of records, it might be worth refraining from initiating a position at current levels.
And sometimes, a company can even be undervalued as it reaches new market highs (yes, even in this market). Aflac (AFL) currently trades at $55.58, roughly in line with the 52-week high of $56.04 that the company reached earlier this month. Aflac is essentially a Japanese company (it does 75-80% of its business in Japan), and the strong operational results have been masked by the weak performance of the yen relative to the dollar.
Analysts have rosy estimates of over $8.50 per share for Aflac's 2017/2018 earnings, and that is especially impressive considering that 94-96% of Aflac's investment portfolio is currently investment grade. Earnings have been growing by 12% annually over the past five years, and the company currently trades below both its 160% price-to-book ratio and 10x earnings ratio that may indicate fair value.
One of Charlie Munger's important observations is that certain high-quality companies are almost always raising intrinsic value over most observable periods, and establishing "new market" highs is easy to evaluate when you examine whether the prices are earnings justified.
When you look at GE and Chevron, both companies seem fairly valued barring a significant turn for the worse in the business cycle. Bank of America trades a little bit above its tangible book value, and that can be an indication of fair valuation (but certainly not of overvaluation). Brown Forman and Hershey worry me a bit, because Brown Forman has not been this expensive in the past generation of records, and the last time Hershey got this expensive was during the dotcom bubble. In the case of Aflac, there is a reason to believe that the stock is undervalued based on book value and P/E ratio metrics. Breaking down the evaluation process into these discrete steps can make judging the new market highs easier to handle.