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Investing When The Market Is Overvalued


The market is overvalued from a historical perspective.  The image below shows the Shiller PE Ratio over time for the S&P 500.

Shiller PE Ratio
Source/Note: Data from through 11/22/22.  The Shiller P/E ratio uses average earnings over the last ten years for the denominator in the P/E formula to smooth out and account for periods of temporary earnings declines, like COVID-19 related earnings declines.  This makes it a generally better metric for historical market valuation comparison than the standard P/E ratio.

The Dot Com Bubble

Only the tech boom of the late 90’s and early 2000’s, and the peak of 1920’s market euphoria, saw a higher Shiller PE Ratio than we currently have.  Those market rallies ended in steep market declines.  But not all stocks fared the same.  For the Dot Com bubble, stocks that were most propped up by the bubble fell the hardest.

When valuation multiples are too high relative to what growth turns out to be, a stock can be a poor investment even though the underlying business continues growing.

“For the investor, a too-high purchase price for the stock of an excellent company can undo the effects of a subsequent decade of favorable business developments.
– Warren Buffett

Shares of Cisco (CSCO), Oracle (ORCL), and Amazon (AMZN) all fell by more than 80% from previous highs during the bursting of the early 2000’s tech bubble…  And these are not the companies that ended up failing completely.  Cisco in particular is a good example of an excellent company that traded for far too high of a price in the tech bubble.

Cisco as a business has done well and increased shareholder value on a per share basis over time.  However, the stock was swept up in the tech bubble of ~20 years ago.  And the company’s stock still has not reached its previous highs, despite strong earnings-per-share growth.Cisco Historical EPS and PriceSource: Data from Ycharts.

Meanwhile, many blue-chip non-tech companies saw much lower drawdowns during the Dot Com Bubble.  Johnson & Johnson (JNJ), 3M (MMM), and Colgate-Palmolive (CL) all saw drawdowns under 40% as examples.

A Market Of Individual Stocks

The stock market is made up of individual securities.  We believe that securities that are undervalued now are less likely to see as steep of drawdowns in a valuation-based market sell off.  We expect companies with the most inflated valuations to fall the farthest.

Despite the market’s high valuation level as a whole, there are many individual securities still trading at bargain prices.  We analyze high quality dividend stocks trading at fair or better prices in The Sure Dividend Newsletter.

When good values are available, we advise investing, regardless of overall market levels.  We know the market is overvalued, but we don’t know when market valuations will fall.  It could be next week, or 3 years from now.  Waiting to invest means missing out on compelling investments available now.

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