Markets are arguably expensive by history, but this environment of accelerating not only earnings but also economic strength is what’s catching the market’s attention right now.
At a first glance, the US markets look expensive because the S&P500 is currently trading on a price-to-earnings ratio of 23 times. The only time the markets looked more expensive by using the same metric was before the dot.com bubble in the late 90s when the price-to-earnings multiple was at 29.5 times.
What is the price-to-earnings ratio?
The price-earnings ratio (P/E ratio) is the ratio for valuing a company that measures its current share price relative to its per-share earnings. The price-earnings ratio is also sometimes known as the price multiple or the earnings multiple.
So why does the US market continue to rally?
The price-to-earnings ratio is using historical earnings. Analysts are forecasting that per-share profit in the S&P 500 will rise 15 percent in 2018, the fastest rate since 2011. They expect growth to approach 13 percent a year through 2023.
Incorporating the above forecasts, stocks look as though they are getting cheaper. Even with the S&P 500 sitting 47 percent above its February 2016 low.
While the current 1.43 PEG ratio still exceeds the average of 1.24 since 1985, it’s down from a record 1.72 in early 2016 and trails readings during four distinctive periods.
What is the PEG ratio?
The price/earnings to growth ratio (PEG ratio) is a stock's price-to-earnings (P/E) ratio divided by the growth rate of its earnings for a specified time period. The PEG ratio is used to determine a stock's value while taking the company's earnings growth into account, and is considered to provide a more complete picture than the P/E ratio.
Conclusion
The data may be one reason why stocks continued to rally, defying forecasts that elevated valuations means muted returns. The S&P 500 has risen every day this year, building on the best annual gain since 2013 amid expectation that a pickup in profit growth will help alleviate pressure from stock multiples.
Disclaimer: This article was issued by Kristian Camenzuli, Investment Manager at Calamatta Cuschieri. For more information visit, www.cc.com.mt. The information, view and opinions provided in this article is being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice.