With stocks up about 6% this year as of Friday’s close, one might assume that the stock market is having an average year. And in terms of return compared to times past, that’s probably a fair assessment. When you peel back the onion, however, you’ll see two sharp declines, yet two very solid — and quick — price recoveries. Unless we have a very quiet Q4, 2016 may prove to be the most volatile market stanza since our exit from the financial crisis about seven years ago.
But as Hillary and the Donald reach the home stretch in this year’s somewhat dysfunctional battle for the Oval Office, something tells me more stock market fireworks are in store before we bid adieu to year.
Stock market bears continue to predict something ugly looming in the not-too-distant future. High valuations coupled with a lackluster global economy, political gridlock, and a generally over leveraged society seem to be at the heart of the argument. And I’d concur — there is reason to be concerned. Especially if you’re just now contemplating putting money to work in stocks.
Still, despite some of the macro-concerns, it’s hard to argue that equity valuations are as bloated as what they were 15 years ago during the tech bubble, or that real estate speculation and derivative toxicity are where they were 10 years ago. Whether history will look back upon this period as some sort of bond or amalgamated credit bubble is yet to be seen. The fact that some think it might should give investors some pause before running out to randomly buy stocks.
Valuation Is Critical
Whatever one’s macroeconomic convictions are (or aren’t), buying stocks at reasonable valuation is a critical investment fundamental. While some strategists might argue that the long-term investor shouldn’t fret too much over what price to buy a stock at, I’d beg to differ.
If you are violating cardinal investment logic, for example, always tending to buy high and sell low, your long-term investment performance will dramatically lag relative to the investor who buys low and sells high. It’s not rocket science, but as the emotional tide moves in, those who think they are disciplined invariably find out they are not.
Thus, while there are clearly stocks in the current market that have been driven up in value as a result of their durable business models, dividend yields and dividend growth, or other defensive attributes, it’s not necessarily in your best interest to chase after them at any price.
It might be better to look at something selling at a cheaper valuation, which seems to have correctible near-term problems or where the stock market seems to have overcorrected to the downside.
If a stock’s price has risen on average 20% over the past five years, yet its earnings growth has been only 10% on average, it’s not likely that trend will continue. And while the holy grail of price-to-earnings a.k.a. the P/E ratio is usually a heavily keyed-on attribute, it’s not the only thing that investors need pay attention to in terms of corporate pricing.
Not every stock is priced at a premium earnings multiple however. Boeing, for example, is currently trading at about 13X next year’s expectations. Compare that to Procter & Gamble, which sells at 20X forward earnings. You could currently buy industrial /technology conglomerate Honeywell at 15X 2016 earnings, but you’ll be paying a whopping 25 for KraftHeinz. And finally you can get tech networking giant Cisco at about a 12, while you’d have to pony up about double that to own Costco.
While the market’s valuation may make some stocks more vulnerable than others in the case of a broad-based market selloff, investors who can consistently pick through the forest and find attractively priced trees should do fine over the long run.
Trying to predict whether the market will get hit 25% by the end of the year or where it will be in 2019 is really a fool’s errand. Everyone’s got an opinion – and most of those opinions will end up wrong. Successful investors don’t get bogged down in concerning themselves with what will happen tomorrow. They focus on trying to find securities with solid, durable business models and try to buy them at reasonable prices.