Ignore Valuations? By Jonathan Clements
Make no mistake: Stocks are expensive, with the companies in the S&P 500-index currently at 28 times trailing 12-month reported earnings, offering a dividend yield of just 1.3% and sporting a Shiller price-earnings ratio of 37. All three metrics suggest stocks are pricey by historical standards.
Meanwhile, with far less risk, investors can collect 4.5% in annual interest with 10-year Treasury notes and an inflation-adjusted 2.1% with 10-year inflation-indexed Treasurys. Alternatively, for those who favor cash investments, there’s Vanguard Federal Money Market Fund (symbol: VMFXX), with its 4.2% yield.
With stiff competition from conservative investments, and with all the talk of slower economic growth, you’d imagine that stocks would trade at lower valuations—or, at least, that would be my guess. So why are valuations so rich? Three possibilities:
Investors are anticipating that corporate earnings will soar. Perhaps investors are, but S&P Global sure isn’t. The research firm behind the S&P 500 is forecasting as-reported earnings will climb 15% in 2025 and another 15% in 2026—healthy gains, but hardly the stuff of irrational exuberance.
We’ve moved into an era where stocks have been repriced to permanently higher valuation levels. This might reflect the high growth rate of today’s mega-cap U.S. stocks, notably technology shares. Alternatively, it may be that investors are simply much more comfortable holding stocks than they were three or four decades ago. I say all this with trepidation given the infamous remark made by economist Irving Fisher just before the 1929 stock-market crash: “Stock prices have reached what looks like a permanently high plateau.”
The valuation yardsticks we’re using don’t capture how valuable today's companies are. For instance, because companies are using so much of their spare cash to buy back shares, they’re less focused on paying dividends, so it’s hardly surprising dividend yields are low by historical standards. Similarly, because today’s high-growth companies are rich in intellectual capital, they look far less appealing when their share prices are compared to traditional measures of corporate assets.
None of this is prompting me to make any portfolio changes. I long ago concluded that valuation measures were no predictor of short-term stock-market movements, and that my best bet was to buy, hold and look to the long term. Still, if the economy slowed sharply, I imagine today's rich valuations mean share prices could suffer a steep decline.
Meanwhile, with far less risk, investors can collect 4.5% in annual interest with 10-year Treasury notes and an inflation-adjusted 2.1% with 10-year inflation-indexed Treasurys. Alternatively, for those who favor cash investments, there’s Vanguard Federal Money Market Fund (symbol: VMFXX), with its 4.2% yield.
With stiff competition from conservative investments, and with all the talk of slower economic growth, you’d imagine that stocks would trade at lower valuations—or, at least, that would be my guess. So why are valuations so rich? Three possibilities:
Investors are anticipating that corporate earnings will soar. Perhaps investors are, but S&P Global sure isn’t. The research firm behind the S&P 500 is forecasting as-reported earnings will climb 15% in 2025 and another 15% in 2026—healthy gains, but hardly the stuff of irrational exuberance.
We’ve moved into an era where stocks have been repriced to permanently higher valuation levels. This might reflect the high growth rate of today’s mega-cap U.S. stocks, notably technology shares. Alternatively, it may be that investors are simply much more comfortable holding stocks than they were three or four decades ago. I say all this with trepidation given the infamous remark made by economist Irving Fisher just before the 1929 stock-market crash: “Stock prices have reached what looks like a permanently high plateau.”
The valuation yardsticks we’re using don’t capture how valuable today's companies are. For instance, because companies are using so much of their spare cash to buy back shares, they’re less focused on paying dividends, so it’s hardly surprising dividend yields are low by historical standards. Similarly, because today’s high-growth companies are rich in intellectual capital, they look far less appealing when their share prices are compared to traditional measures of corporate assets.
None of this is prompting me to make any portfolio changes. I long ago concluded that valuation measures were no predictor of short-term stock-market movements, and that my best bet was to buy, hold and look to the long term. Still, if the economy slowed sharply, I imagine today's rich valuations mean share prices could suffer a steep decline.
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