You will have noticed by now that those who talk stock often talk of valuations, such as the price to earnings ratio, or P/E. Countless studies have shown that the public is mostly unimpressed / bored by this, so you may wonder we continue to do it. We look at P/E because doing so is an essential step in the process of translating our insights, guesses, and assumptions about stocks into numbers. As a means of gauging a stock’s value, P/E is imperfect even at the best of times, particularly in absolute terms, since it is a measure of how much we are paying for what a company earns based on the price of its stock, and there is no means of computing any theoretically best amount for that.
Despite that, P/E works pretty well for comparative purposes, and that is how I use it now; by comparing the current average P/E of S&P 500 stocks to past average P/Es of S&P 500 stocks, it is possible to gauge the market’s overall confidence. What we find, given an average P/E of just over 24, is that stock buyers believe earnings are likely to be increasing across the board and stock prices rising for years and years to come, probably at a somewhat faster rate than they have been rising for the past seven years.
The problem is that no one actually believe that. Prices are being driven not by value, but by fear of missing out. I’ve assembled a list for today of what I believe are the worst offenders.
Remember to treat these ideas as just that, ideas, and do your own research before making any investment decision.