Mitch's Mailbox

July 20th, 2017

Are P/E Ratio’s Too High?

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Tyler B. from Baton Rouge, LA asks: Mitch, I saw an article the other day stating that P/E ratios are way above average and that something has to give. I’m a long-time investor, and I recently inherited some money, but I’m considering just keeping that money in cash because buying now would mean investing in overpriced stocks. What do you think?

Mitch’s Response: Articles about P/E ratios have been appearing more lately, which I think is largely in response to comments being made by Federal Reserve governors about potential frothiness in the market. The Federal Reserve Chairwoman, Janet Yellen, has been a part of this valuation narrative, making waves some months ago when she noted that the committee was taking notice of high equity prices “relative to historical standards.”

These comments are not without merit. As of the end of Q2, the forward P/E on the S&P 500 was 17.5x, which is materially higher than the 25-year average of 16.0x and also notably higher than the 15.4x average we’ve seen since 2000. To note, forward P/Es are calculated based on expected earnings for the S&P 500 relative to current prices, which while imperfect are more useful than looking backward.

Bottom line: stocks aren’t cheap. But, I wouldn’t call them overpriced, either. S&P 500 earnings growth hit 14% in Q1, and Zacks Investment Management expects full year growth to approach 10%. As long as corporations are hauling in earnings and revenues at that rate, I could envision valuations moving even higher.

Remember, too, that the last time we saw forward P/E ratios at current levels was early in 1998. That was a volatile year, but the S&P 500 still finished +28.34% higher and added another +20.89% in 1999. That eventually saw forward P/Es peak at close to 25x, when the bubble burst. We are not really close to those levels yet.

Another thing I’d like to point out is that the Feds speak on elevated P/Es has not been a reliable indicator in the past. Do you remember Alan Greenspan’s declaration of “irrational exuberance” back in the 1990’s? It is often viewed as a prescient forecast of the bubble bursting, but there’s one huge problem with it: he made that statement in 1996. Stocks more than doubled from the time he made that statement to when the bubble burst! In other words, it hasn’t been a wise move in the past to take Fed officials at their word, and I don’t necessarily think it’s a wise move now.

Does that mean you should invest all of your cash now? Not necessarily. It really depends on your long-term objectives for that money and how much of it you may need in the near term. If you want ideas for how Zacks Investment Management would put that money to work, just reach out to one of our Investment Advisor Representatives at 1-888-600-2783 and we will put together a proposal for you based on your goals.

And, if you would like to learn more about how to invest in a market for the long-term, check out our guide, Three of Our Top Performing Strategies Revealed.  This guide outlines three Zacks strategies that can help you achieve growth and value. These strategies have been ranked in the top of hundreds of others in their respective universes by Morningstar. Learn more by clicking on the link below:

Disclosure

DISCLOSURE This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. Do not act or rely upon the information and advice given in this publication without seeking the services of competent and professional legal, tax, or accounting counsel. The information contained herein has been obtained from sources believed to be reliable but we do not guarantee accuracy or completeness. Publication and distribution of this article is not intended to create, and the information contained herein does not constitute, an attorney-client relationship. No recommendation or advice is being given as to whether any investment or strategy is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. All information is current as of the date of herein and is subject to change without notice. Any views or opinions expressed may not reflect those of the firm as a whole.

Past performance is no guarantee of future results. Inherent in any investment is the potential for loss. Zacks Investment Management, Inc. is a wholly-owned subsidiary of Zacks Investment Research. Zacks Investment Management is an independent Registered Investment Advisory firm and acts as an investment manager for individuals and institutions. Zacks Investment Research is a provider of earnings data and other financial data to institutions and to individuals.

Returns for each strategy and the corresponding Morningstar Universe reflect the annualized returns for the periods indicated. The Morningstar Universes used for comparative analysis are constructed by Morningstar (median performance) and data is provided to Zacks by Zephyr Style Advisor. The percentile ranking for each Zacks Strategy is based on the gross comparison for Zacks Strategies vs. the indicated universe rounded up to the nearest whole percentile. Other managers included in universe by Morningstar may exhibit style drift when compared to Zacks Investment Management portfolio. Neither Zacks Investment Management nor Zacks Investment Research has any affiliation with Morningstar. Neither Zacks Investment Management nor Zacks Investment Research had any influence of the process Morningstar used to determine this ranking.

Questions posed are for demonstrative and informational purposes only and may not reflect the views of current clients or any one individual
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