Due to the recent popularity of my recent article regarding stock market valuations I have decided to update the serious on a regular basis. I contemplated as to how often I should update the series. I think weekly is too much, I considered quarterly but I think in today’s volatile markets too much changes in a quarter. Officially the VIX is low now, but I think there is still enough fear in the market to cause volatile swings. In addition, due to the rapid changes in the economic environment earnings and other measures of corporate activity will be changing frequently. I concluded that updating market valuations on a monthly basis would be logical and a benefit to the readers. I decided to use the last day of every month as the day to date my data from and to post my article. Due to the holiday season I will be posting a day early for December.
The content will be mostly the same, I will be mostly updating the numbers, and the commentary as to what level the market valuations are at.
Below are six different market valuation metrics as of December 30, 2009:
Current P/E TTM 86
The current P/E TTM 86, which is slightly below the TTM P/E of 87 the market was valued at in early December
On a TTM basis the S&P has a P/E of 86. Based on this data the market is significantly overvalued. However I do not think this is a fair way of valuing the market when considering the significant decrease in earnings over the past year. To get an accurate picture of whether the market is fair valued based on P/E ratio it is more accurate to take several years of earnings.
Current P/E 10 Year Average 20.42
The 10 year P/E ratio is currently 20.42. This is slightly above the 20.05 measure from my previous article in early December.
This number is based on Rober Shiller's data evaluating The average inflation-adjusted earnings from the previous 10 years. This is slightly over valued since the average P/E is around 15. However with interest rates at zero, the market should be trading at a slightly higher P/E than the historical norm. The market with an earning yield of about 5% looks much more attractive than 10 year treasury yields of 3.5%.
Current P/BV 2.22
The current P/BV is 2.22, this is slightly lower than the 2.33 market P/BV in early December.
The average Price over book value of the S&P over the past 30 years has been 2.4. This indicates the market is slightly underbought. Book value is considered a better measure of valuation than earnings by many investors including legendary investor Martin Whitman. He states that book value is harder to fudge than earnings. In addition book value is less affected by economic cycles than one year earnings are. P/BV therefore provides a longer term accurate picture of a company's value, than a TTM P/E.
Current Dividend Yield 2.29
The current dividend yield of the S&P is 2.29. This number is unchanged from when I last calculated market valuations in early December.
It is hard to determine on this basis whether the market is overpriced. The dividend yield for stocks was much higher in the begging of this century than the later half. The dividend yield on the S&P fell below the yield on Ten-Year treasuries for the first time in 1958. Many analysts at the time argued that the market was overpriced and the dividend yield should be higher than bond yields to compensate for stock market risk. For the next 50 years the dividend yield remained below the treasury yield and the market rallied significantly. In addition the dividend yield has been below 3% since the early 1990s. While I personally favor individual stocks with high dividend yields, I must admit that the current tax code makes it far favorable for companies to retain earnings than to pay out dividends.
Finally, as I noted above the current economic environment has zero percent interest rates and low bond yields. During periods where yields are low it is logical for income oriented investors hungry for yield to be bid up the market, and dividend yields to decrease. I think it is hard to claim the market is overbought based on the low dividend yield.
Stock Market Capitalization as percentage of GDP 81.2%
The current level of 81.2% is slightly higher than the 79% in early December.
Stock Market Capitalization as a percentage of GDP is another metric albeit less commonly used than other metrics, to value the market. The total stock market index has a current capitalization of about $11.6 trillion. This is 81.2% of GDP which is $14.2 trillion, this is close to the historical average. Between 75-90% market capitalization as percentage of GDP is a fair value, therefore at a current level of 79%, the stock market is fairly valued. Warren Buffett has stated that market capitalization as a percentage of GDP is "probably the best single measure of where valuations stand at any given moment.”
Current Tobin's .91
Tobin's Q is currently .91 is slightly higher than the level of .86 in early March.
Another value of stock market valuation which is less commonly used than many of the above methods are the Tobin's Q. The current level of .91 compares with the Tobin's Q average over several decades of data of approximately .72. This would show that the market is slightly over valued. In the past Tobin's Q has been a good indicator of future market movements. In 1920 the number was at a low of .33, the next nine years included phenomenal gains for the market. In 2000 Tobin's Q almost reached a record high of nearly 2, and the market declined subsequently about 50% by 2003.
1. P/E (TTM)- Extremely overvalued
2. P/E (10 year average)- slightly over valued
3. P/BV - Slightly Under valued
4. Dividend Yield - Indeterminate/ Fairly valued
5. Market value relative to GDP - fairly valued
6. Tobin's Q - Slightly Over valued
In conclusion, the market is definitely not extremely over valued based on the above data. The argument can be made that stocks are slightly over value based. However the historical data fails to take into account current record low interest rates. Taking into account interest rates, the market is be fairly valued currently.