I’ll try not to be a Shill when taking about the Shiller P/E ratio, but it’s gonna be hard. That joke, though, not so hard.
Okay, so what exactly is the Shiller P/E ratio? What it does is it divides the level of the S&P 500 by the average of the S&P 500’s earnings over the last ten years. This is supposed to smooth out business cycles – both good and bad – and give investors a better idea of how the price of stocks compared to earnings over a longer period of time. Earnings might be unreasonably good over one year, or in the case of 2009, really bad as companies took the opportunity to flush away all the crap on their balance sheets.
It’s also called the Cyclicly Adjusted P/E (or CAPE for short), but we’re gonna stick with calling it the Shiller P/E. YOU’RE WELCOME, ROB.
The concept was really first introduced by Benjamin Graham and David Dodd in Security Analysis, but they were talking about individual stocks. They thought that looking at one year of earnings was just too volatile when looking to value a company, so investors should look at an average of earnings over the past decade. I typically do an average of the last five years when I invest, but that’s more to do with the difficulty of a retail investor getting data for a decade.
Here’s a handy Shiller P/E ratio chart for the S&P 500.
Thanks, Gurufocus. That’ll be $100 for the advertising. Okay… we’ll call it even.
On the surface, that looks pretty bad for stocks. At 25.1, the current level is a full 50% above the mean, and is rapidly approaching the levels seen when the market peaked in 2008. If we exclude the outlier of 1999 (buy EVERYTHING on the internet!!!!!), the last time we reached such a high level was 1929, a year I hear wasn’t great for stock market investors.
When I look at the market, it’s definitely overvalued. I’m finding pockets of value, but they’re few and far between. For every beaten up stock like Reitmans, there are 10 that are trading at 20 times earnings. They might be on the Dow Jones 30. LOOK MOM I CAN COUNT BY 10s.
If I had the majority of my wealth in large ETFs that track the market, I’d be a little concerned, but not much. Timing the market is virtually impossible, and you shouldn’t even try. You can argue that value investors try to time the market all day long, but as we all know, value investing can also result in dead money for years. Focusing on buying undervalued companies is a way to time the market, but a pretty poor way at the end of the day.
Getting back to the market top, I’d maybe take a little off the table if I was nearing retirement. It would really suck to have a retirement date three years out, and then end up having a portfolio that was in 100% stocks down 30%. But for somebody under 40? Just stay invested in equities. Maybe raise a little cash so you’ve got some money to buy stocks when they go on sale, but that’s it.
And this is why I don’t care about the valuation of the market in general. I concentrate on holding a portfolio of stocks that I think represent good value. I focus on buying assets for less than what they’re worth, and that’s it. I don’t care about what the underlying market is doing, because I feel like I’m choosing the best of what’s out there. The market might be overvalued, but my portfolio is undervalued.
I’d actually prefer a market correction. I’m tired of choosing between a few dozen stocks that always seem to show up on my screens. I’m tired of living in a world where Target falls 20% after it can’t even keep the shelves full in Canada and it’s called a value stock. I want actual value, not mega cap bias value.
Just focus on buying stocks at good value. Or, because you’re lazy, just follow whatever I do. I’m onto you, person who keeps outbidding me on MRRM. If you’re sitting on some gains, remember, it isn’t so bad to take some profits.