by Lance Roberts, Clarity Financial
— this post authored by Michael Lebowitz
We talk a lot about valuations and their importance, but such discussions can be hard to put into context.
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Therefore, I have produced a series of charts that visualize various valuations of the S&P 500 companies. Not surprisingly, such also corresponds to the current behavior of Wall Street analysts and investors. Instead of cluttering up the commentary space on RIAPro.Net (30-day Risk-Free Trial), we thought you would better appreciate the charts and can share them more easily in an article format.
The charts below are called heat maps. What we like about heat maps is their ability to show two data points in one easy to read format. The following maps show the S&P 500 components market cap and along with a second factor. The larger the company’s market cap is in relation to other companies in the sector, the larger the square. Each graph has a scale on the bottom right relating to the second factor. In the first graph (Price to Earnings), the brighter the red, the more overvalued a company is. Conversely, green is relatively cheaper. Companies are sorted by their sectors and sub-sectors.
The first three graphs are popular measures of valuation. The fourth graph shows that analyst recommendations, despite valuations, are pretty bullish. As shown in the fifth graph, investors are also overly bullish as there is a very low percentage of short positions in general. Lastly, the sixth graph shows this is not just domestic, but high valuations are occurring in many other countries.
1. Price to Earnings:
You have to look pretty hard to find stocks that are not wildly overvalued.
2. Price to Sales:
A ratio between 2-3 is considered somewhat normal, especially for well established mature companies.
3. Price to Book:
P/B is also typically in the lower single digits for mature companies.
4. Analyst Recommendations
You have to look pretty closely to find stocks that do not have buy recommendations.
5. Short Interest as a % of total float:
The continual grind higher has scared away almost all short sellers.
6. World Price to Earnings:
These are not as extreme as the U.S., but P/E ratios around the world are very high. Keep in mind that historical P/E ratios in most countries are lower than in the U.S. for several reasons. But importantly, P/E ratios are relative to the country that domiciles the company. Therefore, just because it may appear cheap relative to the U.S. does not necessarily mean it is a value.
No matter how you look at the markets, either from a technical or fundamental point of view, the long-term risk/reward is not favorable.
What eventually derails the bullish bias is unknown. However, what is certain is that when it occurs, given the more extreme levels of leverage combined with a lack of liquidity, the reversion will be swift.
During a bull market advance, investors always take on substantially more risk than they realize. Unfortunately, it is a painful lesson taught quickly and repeatedly throughout history.
Investor Resolutions
Here are my annual resolutions for the coming year to be a better investor and portfolio manager:
I will:
- Do more of what is working and less of what isn’t.
- Remember that the “Trend Is My Friend.”
- Be either bullish or bearish, but not “hoggish.” (Hogs get slaughtered)
- Remember it is “Okay” to pay taxes.
- Maximize profits by staging my buys, working my orders, and getting the best price.
- Look to buy damaged opportunities, not damaged investments.
- Diversify to control my risk.
- Control my risk by always having pre-determined sell levels and stop-losses.
- Do my homework. I will do my homework. I will do my homework.
- Not allow panic to influence my buy/sell decisions.
- Remember that “cash” is for winners.
- Expect, but not fear, corrections.
- Expect to be wrong, and I will correct errors quickly.
- Check “hope” at the door.
- Be flexible.
- Have the patience to allow my discipline and strategy to work.
- Turn off the television, put down the newspaper, and focus on my analysis.
These are the same resolutions I attempt to follow every year. There is no shortcut to being a successful investor. There are only the basic rules, discipline, and focus that is required to succeed long-term.
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