Are Stocks Overpriced? | Adviser Investments

Are Stocks Overpriced?

Are Stocks Overpriced?
We’ve written about the Magnificent Seven stocks being the force behind the market’s gains this year.

And in light of their eye-catching returns and the overall index’s compelling bull market performance, it would be understandable to ask: Are stocks overpriced?

The chart below shows two valuation measures for the S&P 500 index as well as its 10 largest stocks and the other 490-plus equities in the index.

The first measure illustrates that future earnings per share (EPS) for the 10 largest stocks in the S&P 500 is estimated at 18.8%. That’s an impressive yet arguably unsustainable rate. A more reasonable 11.5% is estimated for the index as a whole, and the figure is 9.8% for the index minus those 10 stocks. For historical context, the average annual EPS for the S&P 500 over the last 20 years has been 8.4%.

By that measure, earnings are expected to be higher than average over the next 12 months. However, given that we’re in a bull market and the economy is expanding (GDP growth was a higher-than-expected 2.6% in the second quarter of 2023), it’s no surprise that earnings have been robust and appear poised to grow.

Is the stock market overvalued?
Note: Chart shows projected compound annual growth rate in earnings per share for the S&P 500, the 10 largest stocks in the S&P 500, and the index minus the 10 largest stocks year over year for 2024. It also shows the estimated price-earnings ratio in 2024 for the same index segments as of 6/30/23. Source: AllianceBernstein.

The second valuation gauge we’ve charted is forward price-earnings (P/E) ratio estimates. This is a simple comparison of the price of a stock or index against its earnings (price divided by earnings). The trend is similar to what we observed in EPS—the 10 largest stocks’ P/E ratios are inflated—but the ratios for the index overall and the index minus those 10 stocks are significantly lower.

In this case, the data points to the majority of the S&P 500 being fairly priced if not undervalued. The 25-year-average P/E for the entire index is 16.8, below the current forward estimate of 17.7. But once you remove the 10 largest stocks, the 490-plus remaining index components have a reasonable valuation of 15.3.

Given that the average bull market from 1929 onward lasted 1,011 days and generated a return of 114%, the fact that we’re only 280 days in with a 28% gain gives us confidence that opportunities remain for investors to see additional growth—at a reasonable price to boot. And even if the Magnificent Seven falter, or if the trend shifts to favor lagging segments of the market, today’s prices indicate that most of the market is a relative bargain.

We’re watching the trends closely to find growth opportunities and manage clients portfolios in this bull market. Are stocks overpriced? We’re not so sure.

This material is distributed for informational purposes only. The ideas and opinions contained herein should not be viewed as recommendations or personal investment advice. Data and statistics contained in this report are obtained from what we believe to be reliable sources; however, their accuracy, completeness or reliability cannot be guaranteed.

Our statements and opinions are subject to change without notice. You may request a free copy of the firm’s Form ADV Part 2, which describes, among other items, risk factors, strategies, affiliations, services offered and fees charged.

All investments carry risk of loss and there is no guarantee that investment objectives will be achieved. Past performance is not an indication of future returns. Tax, legal and insurance information contained herein is general in nature, is provided for informational purposes only, and should not be construed as legal or tax advice, or as advice on whether to buy or surrender any insurance products. Personalized tax advice and tax return preparation is available through a separate, written engagement agreement with Adviser Investments Tax Solutions. We do not provide legal advice, nor sell insurance products. Always consult a licensed attorney, tax professional, or licensed insurance professional regarding your specific legal or tax situation, or insurance needs.

For a summary of Adviser Investments’ advisory services and fiduciary responsibilities to our clients, please review our Form CRS here.

© 2023 Adviser Investments, LLC. All Rights Reserved.