Is market overvalued and by how much?

Talks of overvaluation have been going on for the last couple of years or so.

By looking SP500 last 20 years normal PE has been about 17.8. Currently we are at 19.9.

sp50020 Is market overvalued and by how much?
Fast Graphs figure

 

But it is not this simple. As all of you know, value of company is basically it’s future earnings. So to make meaningful conclusion, we need to take earnings growth into account. Average adjusted earnings growth in SP500 has been 6 percent on yearly basis in last 20 years. Forecasted earnings growth for next couple of years is 11.8%.  If we assume new normal PE to be 19.2 after two years, we get projected total yearly return of 11.8% which includes about 2% of dividends.

 

sp50003 Is market overvalued and by how much?
Fast Graphs figure

 

Average PE in last 5 years has has been 18.2. This means that on short term, market is about 8.5% or so overvalued. However if forecasted growth materializes, estimated total return can be still in the ball park of 10%.

So I will be buying more(adding leverage) if market goes down more than 8%. So I see little bit of down side in short term but nothing to get scared by for long term investor. I will be making regular dividend investing on company by company basis and possibly sell some highly value stocks. I have sold BRK.B and LMT from my portfolio couple of days ago but I will remain 125% invested as whole.

 

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Keep on investing!

 

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