The Overall Stock Market Is Not In A Bubble
Dividend Investing
Seeking Alpha Analyst Since 2008
Association with SA author Evelyn Trias
Contributor, CNBC
Producer of "The Quarterly Compounder" channel on YouTube.com.
Summary
- At first glance, the price/ earnings ratio for the S&P 100 looks very high and supports the idea that the market is in bubble territory.
- The reason why the PE ratio for the S&P 100 appears high is because 12% of the index is weighted into just four stocks with unusually high PE ratios.
- Take out these four statistical outliers and the overall valuation of the S&P 100 looks much cheaper.
I recently read an article here on SeekingAlpha that argues we are in an historic bubble and that investors should sell all their stocks and bonds and hold cash and commodities for the next seven years. The premise for this rather alarming course of action assumes that we are, in fact, in a bubble. So are we?
To try to answer that question, I looked at the 100 holdings of the Ishares S&P 100 ETF (OEF), took the PE ratio for each holding (using Googlefinance as the data source), and took the weighting of each position according to the IShares homepage. I then screened out any PE ratios that are zero or less. Next, I checked the PE ratios from Googlefinance against those I found on SeekingAlpha. For example, Googlefinance retrieves a PE ratio of 1684 for Tesla (TSLA). I swapped that out for the SeekingAlpha reported PE ratio of 343. After double checking the data, I then generated an overall weighted average PE ratio for the entire S&P 100 of 48.
Squarely in bubble territory.
But you have to dig deeper. Look what happens if you screen out JUST ONE STOCK from the S&P 100. (TSLA) comprises over 3% of the S&P 100 according to Ishares and has a PE ratio that is dramatically outside the bell curve of PE ratios for stocks in the S&P 100. I removed that one single statistical outlier and re-weighted 3% of the portfolio using the resulting average PE ratio, and found that the overall weighted average PE ratio for the whole S&P 100 drops precipitously to 38.5.
Amazing how just one stock can so extremely skew the average PE ratio for the entire index.
But in fact, the S&P 100 is weighted towards a few other statistical outliers with PE ratios that Googlefinance reports at close to 100 (over two times the index average). Amazon (AMZN) currently comprises over 6% of the entire S&P 100, (NVDA) comprises 1.5%, and Disney (DIS) comprises another 1.5%. Take out those other three statistical outliers and the PE ratio for the entire S&P 100 drops down to a far cheaper level of 32. That tells a radically different story than an index with an average PE ratio of 48.
Conclusion
You can't infer that the whole market is in a bubble until you look at the impact of statistical outliers on the overall average PE ratio for the index. 4 companies in the S&P 100 may very well be trading in extreme bubble territory, which disguises the fact that the remaining 96 companies in the index aren’t. Here is a link to the data.
Analyst's Disclosure: I am/we are long AMZN.
I am not an investment advisor and this is not investment advice. I cannot guarantee the accuracy of any computation or any data source that I relied on when I did the calculations.
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