One of the key issues in the stock market revolves around the idea of valuations. Cutting to the chase, the question is whether or not the growth rate of the economy and, in turn, earnings, is strong enough to justify what most see as lofty valuation levels in stocks.
One of the key lessons I’ve learned in my 30+ years of managing other people’s money for a living is this: “Stock market valuations don’t matter until they do. But then they matter a lot.” So, the real question of the day is if valuations matter here.
The bulls argue that the combination of the current low level of interest rates, slow-but-steady economic growth, and the anticipated economic bump from tax reform means valuations are not a problem.
The bears counter with a host of rebuttals including the fact that traditional valuation metrics such as P/E, P/D, P/B, etc. are currently sky high and that even Janet Yellen and Stanley Fischer have publicly voiced their concerns about the valuation levels.
So, this morning I’d like to offer up a host of valuation charts so that you can form your own opinion on the matter.
Let’s start with the Price-to-Earnings ratios. Below are three different versions of the venerable valuation metric. First up is the P/E using GAAP (Generally Accepted Accounting Principles) earnings. Given the degree of “financial engineering” that companies do – including the game of excluding so-called “one-time” expenses that tend to reoccur on a consistent basis – I deem the use of GAAP methods as the only “legit” way to look at the P/E ratio these days.
GAAP Price to Earnings Ratio
My first takeaway from this chart is there appears to be two “eras” involved. I’ve illustrated this by drawing boxes around the distinctly different periods. As you can see, in the first “era” the GAAP P/E stayed in a range between 6.5 and 28. But then the world and the valuation range changed as the two bubbles occurred.
