The U.S. stock market keeps making new highs as the S&P 500 approaches 1900 and many popular media discussions revolve around price-to-earnings or P/E multiples that are far from historical highs.
It’s worth noting that stock P/E multiples are also far from their historical low points, a fact that seems to be conveniently missed by most pundits. Also, P/E’s are only far from their highs if you compare them to the Internet bubble (a likely outlier for valuations).
A look back at history shows that the market has certainly topped at P/E levels in many instances below where they are today. During the 1970s, for instance, P/E multiples were barely double digits before the markets fell over 50% from such levels numerous times.
Granted, interest rates today are near all-time lows and should rightfully be reflected by higher multiples and lower discount rates, but it certainly is not hard to find examples that suggest this market is much nearer a major top than a major bottom.
Case in Point
The first chart below from JP Morgan (JPM) was one we included in our January ETF Profit Strategy Newsletter published 12/20/13 where we reminded our readers, “History, for those of us who still bother with it, teaches us the stock market doesn’t necessarily need to be grossly overvalued before it can suffer a severe correction. Have we already forgotten what occurred in 2007?”
What did happen in 2007?
On the market’s last major price peak, 10/9/07, the S&P (RSP) had a forward Operating P/E ratio of 15.2x. From that point, stocks suffered a 57% decline in price.
As displayed in the graph, today’s forward Operating P/E ratio is also exactly at 15.2x as the following data from S&P also shows. Notice though there are lots of “earnings” numbers to choose from.
The Earnings Game
15.2x just so happens to also be the most flattering of the entire 2014 bunch as even the JPMorgan chart chooses to use what happens to be the lowest 2014 P/E expectation to show today’s valuations versus the two previous major market tops.
I have highlighted in yellow the 15.2 P/E from Standard & Poor’s that JPMorgan uses for their analysis.
Take a look at all the different 2014 forward P/E estimates, though, 15.2x is the lowest one and the one used by almost all the media and people trying to convince us that a market top is not likely because P/Es are too low. They are back end loaded too, meaning analysts think the future will significantly improve over the present.
Forward earnings are notoriously always too optimistic as 2013′s 18.4x was expected to also only be 15.2x in 2012, and we see how that turned out.
Why don’t they look at the Reported Earnings instead? Likely because it doesn’t fit their script.
In reality most accountants and value investors wouldn’t touch operating or forward earnings with a ten foot pole. These earnings often include management decided adjustments such as nonrecurring expenses, and other items not subjected to standardization across companies. In other words there is a lot of liberty in deciding what is operating or not. Therefore they are highly inconsistent over the years.
The “as reported”, “GAAP”, or “real” P/E ratio is the trailing 18.4x number shown in green. This was the actual GAAP earnings posted by the S&P companies at the end of 2013.
Either way you slice it, P/E ratios are certainly at levels that a significant decline could occur from, operating or reported.
For more on P/E ratio games see my January article, “the fallacy of low P/E ratios”.
IPO Valuations Are Extreme by Any Measure
If price to earnings data doesn’t show market froth is here, then maybe more anecdotal evidence will.
According to Sentiment Trader, since October, 74% of all the IPOs (KING) or initial public offerings announced in the U.S. were for money losing companies. That trend no doubt continues through April as four companies went public on 4/4 with a combined loss of $50 million.
Five9 (FIVN), a cloud computing services company, alone accounts for $31.3MM of those losses. Its market cap meanwhile is only slightly higher than its losses, at $42 million. Two of the other three IPOs on 4/4 also were money losers, with lone profitable company, Grubhub (GRUB), profitable by the slimmest of margins.
The last time there were this many IPOs of speculative companies was in early 2000, during the height of the .com bubble in Feb. 2000, when almost 80% of companies going IPO were posting corporate earnings losses.
So far in 2014 there have been 71 IPOs (IPO), up over 100% YTD from an also very hot IPO year 2013. Again, most of these newly minted IPOs have been money losing companies. Is the stock market once again repeating the same frothy mistakes it made back in 2000?
The ETF Profit Strategy Newsletter keeps our investors on the right side of the markets by digging into the numbers utilizing technical, sentiment, and fundamental data. P/E ratios are up to levels that have been associated with previous major market tops. The amount of IPOs also nearing all time high levels, the last seen in the year 2000. Buyer beware.
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