Are Stocks Cheap at this Level? Maybe
“EVEN AFTER THE BIGGEST RALLY SINCE THE 1930s, U.S. stocks remain the cheapest in two decades as the economy improves,” according to an April 26 Bloomberg story. How can that be? Well, digging into the numbers a bit, it appears the statement comes with some qualifiers. First, the “cheapness” is based on the price to earnings ratio (P/E) using forecasted earnings estimates. By that measure, the S&P 500 is trading at 14.1 times forecasted earnings. As you know, forecasts may or may not come true so, if earnings actually fall short of the projection, then today’s P/E will be higher in retrospect.
Second, while the Bloomberg headline said stocks were the cheapest since 1990 based on analyst estimates, the article qualified that and said, “except for the months after Lehman Brothers Holdings Inc. collapsed.” So, yes, stocks may be cheap now, but they have been cheaper in the recent past.
But wait, in the same article, Bloomberg points to another market valuation measure that says the market is significantly overvalued. Using the 10-year average corporate earnings model popularized by Yale economist Robert J. Shiller, the P/E on the S&P 500 is currently about 22, which is well above the historical average of 16.
Bulls will point to the P/E using forecasted earnings estimates and say stocks are cheap. Bears will point to the Shiller calculation and say stocks are dear.