Ask 10 different money managers what metric they use to determine if a stock (or particular market) is overvalued, and you'll more than likely receive 10 different responses. Of course buying at "the bottom" is easier said than done, as we all know so I submit to you this perspective.
Kyle Caldwell, personal finance reporter at the Daily Telegraph, determined whether stock markets were undervalued or overvalued. Caldwell used three measures: price to earnings (P/E), cyclically adjusted price to earnings ratio (CAPE) and price to book (P/B). His analysis included 34 countries, both developed and emerging and compared current measures to historical averages.
The CAPE adjusts for cyclical variations and takes a longer term view than the P/E considering the earnings average over the last 10 years instead of the 12 month average. Its premise is that eventually earnings will move back to their long term trend. Price to book divides the current value per share over the equity value shown in the company’s balance sheet. The latter includes the value of buildings, intangible assets and other assets if they were to be liquidated. Price to book helps analysts adjust for any distortion caused by companies overstating earnings.
Some of these countries are undervalued because of political or financial unrest including Turkey, Russia and Greece.
Does that make them a bad investment here? You be the judge. Beauty is in the eye of the beholder and "cheap" depends on your appetite for downside risk (or if you're dollar cost averaging).
By all three measures, the U.S. is expensive. This is likely due to indices such as the Dow Jones Industrials and the S&P 500 reaching record highs and consistent performance after the 2008 financial crisis. Josh Wright, Bloomberg economist and Brian Barnier, strategist at ValueAdvisors, LLC agrees in a Bloomberg Briefs report, that the current CAPE level of 26.2 is high relative to its long term median and its long term average. While it is still below peak levels reached during the 2000 dotcom bubble, it is concerning.
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