How to Value Stocks With the Market Near All-Time Highs

How to Value Stocks With the Market Near All-Time Highs

The S&P 500 has more than doubled over the past five years and sits within 3% of its all-time high as of this writing. In this video from Motley Fool Live , recorded on Sept. 9 , Fool contributors Matthew Frankel and Jon Quast consider whether the market is too hot for investors to handle right now.

Both Matt and Jon agree that stocks need to be considered on an individual basis. Traditional valuation metrics can help, but each company has a specific context that helps investors understand whether it’s overvalued or undervalued. 10 stocks that could be the biggest winners of the stock market crash

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Matt Frankel: Do you think the market is too expensive right now? It’s probably the toughest question I’m going to ask you today.

Jon Quast: It is a tough question, Matt, and the reason I think it’s tough is because there’s two elements when you’re valuing the market, when you’re valuing individual stocks. On one hand, you have the pure math of it that’s very objective. We’re going to explain what the price-to-earnings metric is, what the price-to-sales metric is. These are easily calculated. They’re simple math and it’s very objective.

Yet, they’re kind of useless because there’s this whole other element that goes into it, that is context. The context is very subjective. But without the appropriate context, you really can’t understand the valuation. There’s the element of objectivity and subjectivity playing together, that makes it a very complicated question.

Frankel: One thing that I hear all too much, especially on Twitter from a lot of people is, valuation doesn’t matter when you are talking about growth stocks . I usually end the conversation there. I consider myself to be probably the most value-oriented investor at the Fool, I’m definitely a value investor at heart. But the definition of valuation, it is different depending on what kind of stocks you are talking about.

With my investment style, I definitely consider valuation. Even the most growthy stocks, the goal of a growth stock is to eventually get to a point where you’re making profits and you can be valued by traditional metrics. Apple started out as a money-losing growth stock. Now you can actually make the argument that it’s somewhat of a value stock based on traditional metrics.

Valuation absolutely matters. No one’s going to buy a growth company with a market cap of $1 trillion if there’s no reason it could ever justify it.

How does valuation come into play in your investing style?

Quast: Matt, I think I’m similar to you in this aspect. Valuation does matter. It’s constantly trying to find that appropriate context like we’re talking about.

I’m going to share my screen real fast, if I can remember how. There it is. This is some research here from Yardeni Research. This is showing the P/E ratio of the S&P 500. I just wanted to put this up here just so people can get a glimpse. This is going all the way back to 1989. The blue line is trailing, the red line is forward. We’re going explain what these mean. But for now, just suffice it to say that the higher the line, the more expensive, by a valuation metric.

You see this big spike here in the blue line is also up on the red line. If you’re saying, yeah, by a P/E ratio, the market is historically expensive.

This is the price-to-sales ratio for the S&P 500. See it over here in 2006, way down under 1.5, we see it right now almost double that at 2.8.

On one hand, that would say that we are overvalued but there’s context. The top five stocks make up a disproportionate size of the S&P 500 more than they ever have. That plays into it. Those are some quality businesses that deserve a higher valuation so they’re dragging the whole market up. It plays a part of my investing style. But it’s not the whole thing, so constantly trying to find that context.

I’ll throw one example out there: […]


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