For people who think stocks are overpriced: what would be an appropriate price and how did you come up with that number? I haven't seen an answer to this yet from the "stock market is irrational" crowd.
I think in 99% of cases it's just a feeling - that the decline should have been bigger given how bad the economic impact seem.
When I say "I think stocks are overpriced" I don't necessarily have a specific number in mind. Rather, it's shorthand for "I think that the Fed and USG attempts to avoid deflation at all costs have created an economic environment that over-promotes stocks as an investment vehicle. In addition, I feel that these attempts have worsened inequality by injecting liquidity in a way that increases asset prices more than it increases the velocity of money".
The Shiller P/E ratio for the S&P500 is around 26 now. Mean/median historical values are around 16. So a 40% decline in the stock market assuming no change in earnings would make stocks not seem overpriced to me.
Why do you think the historical value is more valid than the current trend? Is there some dynamic in the market that keeps the p/e ratio above 15, for example?
I would think to calculate a "good" ratio you would need to compare it to returns from property and other investments?
How do you decide that stocks are P/E is too high now as opposed to it being too low in the past. The us equity market has historically had much higher returns than the rest of the world. There's no reason to believe that could continue forever. At some point world markets will reach an equilibrium.
> that over-promotes stocks as an investment vehicle.
But what else is there? Holding cash is terrible because it even loses value and the real estate market feels grossly over-expensive. So if you earn more than you spend, where do you put your extra money? I don't think that bonds, p2p-lending or precious metals perform better in risk/reward.
"But what else is there? Holding cash is terrible ..."
Holding cash might be terrible. Certainly the returns are and it makes sense that (the entire world) would be chasing higher yields elsewhere.
However, if those assets take a 50% haircut at some point in the near future, holding cash will have looked like a fantastic idea.
Given the current Schiller P/E of 26 (!) that was mentioned elsewhere in this discussion, a 50% haircut in US equities is not at all outlandish to consider.
That's my point. Stocks outperforming cash, bonds, and precious metals isn't some universal truth. It's a product of Fed/USG policy (and other factors).
Stocks represent ownership of business producing goods and services and selling them for profit. Cash, bonds, and precious metals are just an accounting mechanism. The value is created by business. So it pretty much is universal truth.
If stock prices represent anything concrete, how is it that Snapchat's market cap is higher than Ford's?
Do any of us actually believe that Snap's stock price is reflective of its value to society?
Today, stock prices are all about perception and company image. Most shares are non-voting, and don't pay dividends. And you can't take your stock and march to a company headquarters to demand that they give you something of value in exchange.
To an average small investor, shares in almost every company might as well be Magic cards. Their only value is to sell them later to a different collector.
> If stock prices represent anything concrete, how is it that Snapchat's market cap is higher than Ford's?
> Do any of us actually believe that Snap's stock price is reflective of its value to society?
of course not. the stock price doesn't represent the value to society; it represents the (perceived) value to investors, taking into account potential for growth. ford is an established, stable company, but it's hard to see any avenues for massive growth over the next decade. I don't personally believe snapchat will grow massively, but it's more likely than ford to do that or get purchased for a huge amount of money by a tech giant.
If you re-read the last sentence of the GP's comment ("To an average small investor, shares in almost every company might as well be Magic cards. Their only value is to sell them later to a different collector"), I think that you're strengthening their position rather than disagreeing with them.
In context, the GGP is positing that stocks should have a higher rate of return than other modes of investment because, to paraphrase, "companies create value". The point of the GP is that perceived value to investors drives the stock price more than value to society, thus countering the notion that stocks are inherently "better".
first of all, whether or not a company "creates value for society" is a red herring. it doesn't matter to an individual looking for an investment vehicle.
> To an average small investor, shares in almost every company might as well be Magic cards. Their only value is to sell them later to a different collector
this is true to the extent that thinking of stocks this way probably wouldn't hurt you as a small investor, but it obscures the reason why stocks have value and are different from bonds. when you buy a stock, you are locking in a fraction of future real productivity, whether or not you can derive cashflow from it directly. with a bond, you are locking in a nominal return, which could result in a real loss over time. although stocks have significantly outperformed bonds historically, I would hesitate to say that one is inherently better than the other; they just carry different risks.
as an aside, I'm really not sure why non-voting shares that don't pay dividends are valuable, but AFAIK, these are not as common as nrclark suggests.
Treating stocks as fractions of future real productivity ignores why companies sell shares in the first place. If the value of a company was wholly in its future real productivity, then companies would never part with ownership. However, companies do sell shares because they need liquidity now, whereas the future value of the company is purely speculative. Shares are but one of many alternatives for companies to raise liquidity. These alternatives provide opportunities to investors with different risk/reward profiles. As you say, there's nothing special about stocks that makes them inherently superior to other forms of investment.
> Most shares are non-voting, and don't pay dividends.
80% of S&P 500 companies pay a dividend [0] and non-voting shares are actually very rare. In fact, Snap even wrote in its IPO paperwork that "to our knowledge, no other company has completed an initial public offering of non-voting stock on a U.S. stock exchange" [1].
Ford's value is low because they pay out 8% dividend yield every yea. This has hurt their growth because other companies are reinvesting that money. Additionally dividends are objectively worse than buybacks because of the tax implications.
Stocks represent ownership and shareholder rights, which extend beyond voting rights.
Equities are a piece of creative energy applied to capital.
I am not saying you can’t lose money with wallstreetbets or that you can’t make a business of cash. But a creative business around money transmission and risk management is equities not cash itself.
Bonds are not just an accounting mechanism; bonds are an alternative to stocks for investment. Even government bonds create value---if not funding something tangible (such as infrastructure), just the existence of a stable and functioning legal system is hugely valuable.
Cash is more than an accounting system too, especially since the end of the gold standard. There isn't a fixed supply of dollars that businesses just move around.
Also, with regards to both cash and precious metals: their value is as media for economic transactions; their value increases each time they change hands. Would you want to barter to buy shares of a company? Trade sheep to invest in Microsoft?
I didn’t say bonds and cash can’t be investments, just that they don’t generate new goods and services. Cash and cash equivalents only generate value through passage of time. There isn’t any creativity involved. Creativity is long term more valuable than just the time value of money.
That same reductionist argument can also be applied to stocks. Share ownership doesn't generate value in and of itself either.
You're saying that businesses generate value. No disagreement from me there.
But then you're saying that stocks are the only way to share the value that businesses create. That's where you lose me. Selling shares is not the only way for a company to raise funds to operate. Companies can also sell bonds or take out loans (i.e. cash). Your argument that stocks are inherently more valuable would only make sense if stocks were the only way to invest in a company.
Without share ownership, there is no business... you can have a business without loans. business generates value. Shares assign ownership. Loans just price risk of capital. Pricing the risk is also a business.
Bonds are very similar to equity. I've just recently realized this.
Companies get funding from two sources, equity and debt. The sum of those are equal to assets in the balance sheet. Both represent different forms of ownership of the company. Equity holders decide how the company is managed, debt holders have priority in income distribution and in liquidation.
Someone already owns a company before company sells (issues / dilutes) shares. That ownership is just shares. No shares need to ever be sold for them to exist. Founders create shares out of nothing when they create a business.
With that line of reasoning you're countering your original point.
If companies don't sell shares, then there's no stock market. If there's no stock market, then there's no rate of return for stocks. If there's no rate of return for stocks, then stocks aren't an inherently superior investment to bonds, cash, or goods.
If someone founds a company that's 100% owned by that one person, then you (as an outside investor) aren't partaking in any of the value that that business creates. Let's say you want part of the ownership of that company. Companies don't just give out shares of ownership because they feel like it. Companies give out shares because they need liquidity. They can exchange fractional ownership for liquidity directly (e.g. selling shares) or indirectly (e.g. giving employees stock options instead of salary). However, shares are not the only way for companies to gain liquidity.
Ownership that is not traded has no value to investors. Ownership that is traded is traded for a reason, and must be compared to alternatives. Those alternatives are not inherently less valuable than shares.
You don’t need a stock market for equity to appreciate. A private business that delivers value makes owning a piece of the business valuable regardless of whether the shares are publicly traded
You can estimate the earnings yield you get on a business based on its price. So, if you have a lemonade stand that earns $100 per year, and you buy it for $100, that’s a great price. You’ll make your money back in a year. After that it’s profit, baby! If you pay $100000, it’ll take 1000 years to earn back your original investment in nominal terms. But it still might be an OK investment, if you are very certain that you can double earnings every year for long enough.
That’s basically how you evaluate what to pay for a company. When you buy stocks, you buy fractional ownership in a company.
Edit: many think the market is overvalued, because it’s currently at historically high price relative to the estimated earnings potential. This, while risk of insolvency for many companies is much higher.
>historically high price relative to the estimated earnings potential
It's high compared to expected earnings over the next year. Which is to be expected, because the ratio of expected lifetime earnings over expected 12 month earnings is also at a high, owing to a pandemic significantly impairing earnings for a year or so but not forever. Looking at 12 month numbers is usually fine as a proxy, but terrible now.
We are still at the highest point ever except for the dotcom bubble and black tuesday of 1929 (and directly before the recent crash, although not by much).
So to answer the parent, pick a ratio somewhere below that. Price has been the main thing moving upward disproportionately for the past decade, now earnings will take a dive.
The Shiller Price earnings ratio is based on average inflation-adjusted earnings from the previous 10 years and the recent earnings weren't really affected by the virus yet and thus the current 10 years of earnings happen to align with the longest period without a recession in US history so it's no surprise that metric is high. The current P/E ratio is 20.53 [0] and there have been many periods in which it has been higher.
We still require a 25% drop in P/E to bring us back to the historical mean. There are reasonable arguments as to why we may never mean revert, why this time is different (possibly permanently low interest rates, stocks as a leading indicator of future inflation due to Fed printing inflating asset prices , etc). But as a rule, I like to bet on mean reversion, not against it.
High Shiller P/E doesn't necessarily mean stocks are overpriced. Intrinsic value is based on future cash flows, what happened 10 years ago may or may not be relevant to future cash flows.
>Why do people conclude that without making a valuation?
Most retail investors are not making any valuations whatsoever. The investment criteria is "this company's future is bright/bad", even though price is the most important factor. Then, recent momentum makes you look good...for now.
Historical rate of return on stocks is about 7%. So in theory, a stock trading at a price to earnings ratio of 14 or less is good value, whereas a stock trading at 15 times earnings is not so much.
However, other factors could play a part, as certain industries are favoured over others, risk, projecting earnings growth, etc.
As such, you can make the argument that stocks are overvalued because they're trading at all time or near all time highs in terms of price to earnings ratios and other metrics. And especially so now given that projected future earnings will have dropped considerably while stock valuations have not.
> And especially so now given that projected future earnings will have dropped considerably while stock valuations have not.
Really that depends on your time horizon. The Fed has signaled that it is willing to act aggressively to boost AD, so that seems to me to be a signal that projected future earnings will not be that low.
If many restaurants, event spaces, etc. fail then it’s possible many people will have to liquidate their savings. This sell pressure would push down prices and likely cascade. The market thus far has been protected by stimulus funds, generous ui benefits, etc. Could that slack be taken up? Sure but it seems unlikely, especially with a second wave of shutdowns. Trying to predict the bottom or top is a fool’s errand. I’m also not sure how ETF/Index funds dispose of assets when they’re sold. They may be a dam holding back a flood.
There's a good interview with Michael Mauboussin[0] in which he mentions the power of regression to the mean and base rates. He gets those ideas from Daniel Khanmen, I think. Anyway, an appropriate price is impossible to predict ahead of time, but using reversion to the mean as your guide, you see that we're pretty overvalued right now.
We're above the mean earnings ratios, FCF yields, etc, while at the same time knowing that we're almost certainly in the first leg of a major recession, and a period unprecedented economic uncertainty.
I think the bear case is much stronger than the bull case right now.
Which stock? If you want to price any individual company, traditional value-based analysis using earnings, assets, and future revenue growth expectations will get you a number. This number varies wildly between different companies. If you're talking about a broad index like the S&P, I personally look at 30 years of price history, draw a best fit line to average out growth to a normal level, then discount 7% for our current economic trough (5% output drop Q1, likely 10% or more this quarter). By this method, S&P should be somewhere around 2150.
The problem, of course, is that we've been in an unprecedented financial situation since 2009 fueled by massive debt inflation among corporations due to near-free money from the government for an entire decade. When will the party end? Who knows. The other problem is that it's hard to predict what will happen post-lockdown globally. As a result, traditional analysis is easily beat by irrational investment even on multi-year timescales these days.
> For people who think stocks are overpriced: what would be an appropriate price and how did you come up with that number? I haven't seen an answer to this yet from the "stock market is irrational" crowd.
> I think in 99% of cases it's just a feeling - that the decline should have been bigger given how bad the economic impact seem.
As you are suggesting, prices are simply what they are, whether or not someone views them as being "too high" or "too low" the only Goldilocks price is the one you agree to.
However, the markets can be distorted. The Federal Reserve, through policies such as lowering interest rates to zero, eliminating reserve requirements, and announcing purchases of corporate debt, has all but published "we will not let the stock market crash under any economic circumstance" as their official policy.
That seems like it would be a terrible idea. The ability to create money up until the point of inflation seems like a key tool to manage economic disasters like COVID-19.
There’s no inflation when the fed buys corporate bonds or bails out failed corporations. It is just propping up the market.
If the fed had given that money directly to consumers we might have inflation problems. They’ll never do that. Socialism only exists in America for corporations.
The fed cannot give directly to consumers. However, congress can and did give directly to consumers with the 1200 check, the 600 a week increase in unemployment, and indirectly by funding payroll for small businesses and the airlines. However, that created a whole lot of debt which the fed has been predominantly buying with their printed dollars as you can see in their balance sheet [0].
You're reasoning from a price change. Inflation is flat/decreasing only slightly because of the "printing", otherwise it would be sharply downwards.
The fed is engaging in aggressive monetary policy to prevent deflation.
The suggestion that buying corporate bonds (while holding everything else constant) is not inflationary is just not right. You can hold on to your mistaken beliefs, but just know that if you do so, it is in willing ignorance of the facts.
SPX at ~1600 so that CAPE matches its historical median. 1600 would be the "neutral" position on that metric.
And, if history is any guide, SPX can fall all the way to ~500 without breaking all time lows on CAPE (this would be extreme, but is not entirely impossible, and inflation is not required for this scenario - look at 1950s).
Numbers would have to be adjusted if inflation speeds up. It hasn't sped up at all yet, in fact all we see today is deflation.
A stock is worth whatever people will pay for it. However it's fair to point out that the price does not match the underlying asset or its future growth.
It's a 2 month old article by perhaps the most respected figure in valuation. He came up with 2750 for S&P at that time (market value was much lower, maybe he would be more pessimistic now). You can enter your own assumptions into his spreadseet and it will output a valuation.
That's easy. You come up with that number because the market organically came up with it thru supply and demand. You could argue the government interfered unfairly but the price is the price either way.
I don't agree because that argument says that the price is sensible because it is the price. You could equally make that statement about the price of tulips in 17th Century Holland, where "single tulip bulbs sold for more than 10 times the annual income of a skilled craftsworker." [1]
Of course the price is what it is due to supply and demand but I don't think that's what most people mean when they say the price is 'not sensible'.
The stock prices are so high because stocks and real estate are the only investments that might provide any sort of real return, and we've been in that situation since bond returns crashed in the wake of the 2008 financial crisis. In that context, stock values are massively inflated (in terms of P/E) relative to what investors may have considered sensible before 2008.
Full disclosure, I hold a short GOOG position right now, but I'm long on a similar company, so it's a hedge. I don't think Google's worth more today than it was on Jan 1. You're right that it's a feeling, but it seems crazy to think that with 15% unemployment, it's still worth that.
I'm also leaning towards a longer recovery in consumer discretionary right now. Someone posted a story here about how people started self locking down before government lockdowns. While I think people are over the strict versions and are ready to get out of the house, I also think they'll be slow to return to malls and movie theaters.
> I don't think Google's worth more today than it was on Jan 1. You're right that it's a feeling, but it seems crazy to think that with 15% unemployment, it's still worth that.
Pricing takes into account projected future earnings.
I have most of my stocks in FZROX which is a total market index.
It does make me wonder how many people are using total market indexes without caring about anything in them and how that could prop up the underlying assets.
This isn’t an original idea, there’s been lots of talk about index funds being a bubble, but there isn’t a great alternative.
Though I’m starting to wonder if I should pull most of the money out and split it between Apple, Amazon, Google, Microsoft, and Facebook.
The long tail of the market index funds I find more likely to have issues than these companies (particularly Amazon and Apple).
I would personally compare the current price to past prices. If the S&P500 price has been the same this past couple of weeks as it was in, say, October 2019: then I might interpret this as the markets predicting that future earnings today are similar to future earnings as one would predict in October 2019. The markets may turn out to be right about this, but it's a very surprising prediction given the current economic carnage.
Of that list, I understand why MSFT, AAPL, AMZN, and NVDA would be up. The rest aren’t so clear to me.
NFLX - streaming is up but consumers exhaust the content library faster and competitors (Disney) will now want to gain market share at any cost
FB, SNAP - exposure to ad dollars (brand, travel, hospitality, entertainment) that won’t be coming back for awhile
UBER - unit economics of food delivery aren’t attractive + hyper competitive market, demand for core rideshare business likely depressed for a long time given it’s dependency on events and business travel
SQ, MTCH - no opinion, neutral sentiment
TSLA - with gas so cheap, electric vehicles are less attractive
I buy the tech multiple expansion thesis but that would apply to every company on this list.
The EV run is on government incentives worldwide, not cost per mile. Outside US the fuel price is marginally related to raw petroleum, i.e. in Europe dropped some 25% when petroleum went down to basically zero.
The stock market is generally governed by two feelings: confidence and fear. Often times those feelings are outwardly feigned for one's own self interest
P/E fails to account for future earnings (ok, so F P/E), it doesn't account for assets and liabilities, and it ignores that security's relative value to other companies an other investments. And suppose profit margins are 7%, annual revenue is $1.2B, throw in a few more stats. What should the company's market cap be?
I think in 99% of cases it's just a feeling - that the decline should have been bigger given how bad the economic impact seem.