In our Hotlist newsletter from last month we took a look at the market’s stretched valuations based on several indicators, and offered insight regarding how actions by the current administration may or may not substantiate them.
The market P/E from the beginning of the year, based on trailing 12-month earnings (as of January 9th ,) was 25. We tracked other metrics as follows:
Shiller P/E: 28.2, up from 25.7 as of the last update in May. This measure, which uses inflation-adjusted 10-year historical earnings to account for short-term fluctuations in profit margins during business cycles, tracked well above the historical mean of 16.7.
Dividend yield: 2.2%–calculated by dividing total annual dividends by stock price. Has held steady since May. As articulated by strategists at Mellon Capital, while an important driver of total returns “building a portfolio of dividend stocks needs to be carried out with precision research insights, and a meticulous focus on underlying company financials.”
Total market capitalization to domestic GDP: 127% versus 116% in May—a metric which Warren Buffett believes is “probably the best single measure of where valuations stand at any given moment,” suggests that market valuations are pretty stretched.
Q ratio: 1.01, up from .95 in May. This metric, created by Nobel Laureate James Tobin, is calculated by dividing the market value of total assets by their replacement costs. This level indicates that the stock’s value is higher than the asset replacement costs, also pointing to an overvalued market.
According to Barclays analyst Jonathan Glionna, Trump’s proposed tax cuts could lead to an S&P earnings boost in the neighborhood of $180 billion, but notes that the path is not a simple one given the variance in effective tax rates among companies in the index and relative impact on different business sectors.
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Our conclusion: Given the valuation backdrop, we believe it’s important to stay focused on finding value. Stocks that trade at low valuations using price-related variables like the P/E, P/B or P/CF are a good place to start.