Is the Market Overpriced?

Full Transcript:

People keep telling me that the stock market is overpriced. What does that mean? And what should I do?

Let’s start by ripping off the Band-Aid. So far, 2022 has not been a great start for your investment portfolio. Tech stocks have led a pullback. Inflation has drastically increased, and the Fed is increasing rates to try and tame inflation. Meanwhile, Russia invaded Ukraine, starting a war. All of these events have had quite the impact on the S&P 500, which is an index of the 500 largest companies in the United States.

To start the year, the S&P 500 was at 4797. Now, since then, it has pulled back over the next three quarters, coming down 25%, getting down to 3586. Now, I don’t know if, in the short term, the S&P is going to go lower. If this is the bottom, and quite frankly, nobody else knows either. What I do know is that there’s different metrics to see is the stock market is overpriced or underpriced relative to its historical averages.

One of these is the forward-looking P/E Ratio. The P/E Ratio is the price of a company divided by the earnings of that given company. In the case of the forward P/E, it’s the projected earnings. Now, when we look at January of 2022, the P/E Ratio was 21.4. And then since then, as the price of the stocks have gone down, the P/E Ratio is also gone down. However, earnings, the denominator, have stayed quite healthy. So therefore, as the market went down, the P/E Ratio went down as well, getting down to 15.1. Now, as you’ll see, this is lower than the 25-year average of 16.8, meaning by this measure, stocks are no longer overpriced.

Now, we’re only looking at a nine-month period here. When we’re investing, we’re investing for the long term. So let’s step back and look at a 20-year period. Let’s go back to October 9th of 2002. If we think back to what was happening then, the tech bubble has bust, and we’re hitting the bottom of that. 9/11 is a year before that, and we’re now deep into the war with Afghanistan. Now, at this point, if we look at the forward-looking P/E Ratio, then it was at 14.1, not too dissimilar from where we’re at today.

However, a big difference is where the S&P 500 was. The S&P 500 was at 777 in 2002. Now, if we look at that versus today, you will see that it has gone up 362%. Now, that’s quite the increase.

How can you make sure you’re participating in the next market increase? I know when you log into your account, and you see that it has gone down from the highs by $100,000, or a quarter million dollars, or even more. That is never a good feeling. However, if you’re in your thirties or forties, you need to remember that this money is going to be invested for 50, 60, or even 70 years. So instead of focusing on the short-term pullback, focus on the opportunity. Take advantage of these buying opportunities by automating your savings. So every paycheck, you’re putting money into the market. With this systematic investing, you will better your future and the future of those you care most about.