Whenever the pool of potential buy candidates begins to dry up as it has recently, I begin to recognize the market as being too expensive. It's also a sign that I need to be a little more selective in my commitments. Just a few months ago I could easily find hundreds of potential buy candidates, but today the number has fallen to only a few. And this is why I keep coming back to the same investment ideas, over and over and over again.
As overall stock prices begin to rise, the market values of the underlying companies also begin to increase. With those rising market values comes increasing investment risks due to overpayment (see chart on right). The easiest way to see this is by watching the rising P/E ratios of individual stocks. As market values are bid up faster than earnings rise, P/E ratios begin to expand rapidly. Quality stocks that could have been bought for 15 to 18 times their earnings just a few months ago are suddenly selling for over 20 times their earnings. And many more are selling for 25 to 30 times earnings. A conservative investor shudders at these values and always takes these statistics into account when deciding on whether to invest his hard earned funds.
Another typical symptom of a rising market are the decreasing yields on equities. When stock prices are rising faster than the companies ability to raise the dividend, the yield will begin to fall. That decreasing yield may just be telling the astute investor that the market is getting a little bit too expensive.
At some point the prudent investor has to wait for value to re-enter the market before once again committing funds.
Another typical symptom of a rising market are the decreasing yields on equities. When stock prices are rising faster than the companies ability to raise the dividend, the yield will begin to fall. That decreasing yield may just be telling the astute investor that the market is getting a little bit too expensive.
At some point the prudent investor has to wait for value to re-enter the market before once again committing funds.
S&P500 P/E Ratio Now I'm not saying that a bear market is imminent, nor am I saying that the bull market is about to come to an end any time soon. I'm just saying that I have certain guidelines that I follow when selecting companies to invest in and as those guidelines are bent, stretched or broken, I need to be a little more prudent in my selection.
As can be seen in the chart to the left, the historical S&P500 has a mean average of 15.51 and a median average of 14.55. Today the S&P500 is quoted at 19.47 times earnings. This is 25% above the historical mean.
As can be seen in the chart to the left, the historical S&P500 has a mean average of 15.51 and a median average of 14.55. Today the S&P500 is quoted at 19.47 times earnings. This is 25% above the historical mean.
S&P500 Weekly Chart A quick view of the 2 year weekly chart (on the right) visually illustrates what's been going on. The market has risen quite nicely over the last two years and since the P/E ratio has been expanding, it's obvious that the market is rising faster than earnings. This can't continue indefinitely. At some point the market will level off and allow revenues and earnings to catch up with the rising stock prices because buyers will become scarce. When that happens, portfolio increases will slow.
In order to keep from falling into this trap, it's prudent for investors to adhere to their individual guidelines and therefore become more selective in choosing investments. The result of increasing investment discipline is always a shrinking pool of buy candidates, which is what I'm seeing in my research today.
Fortunately for investment researchers, there's always a few candidates to buy even in the worst of times. As I find them I'll write about them here on this website. In the meantime I'll continue to buy stocks from that shrinking pool.
Good Luck and Good Trading.
In order to keep from falling into this trap, it's prudent for investors to adhere to their individual guidelines and therefore become more selective in choosing investments. The result of increasing investment discipline is always a shrinking pool of buy candidates, which is what I'm seeing in my research today.
Fortunately for investment researchers, there's always a few candidates to buy even in the worst of times. As I find them I'll write about them here on this website. In the meantime I'll continue to buy stocks from that shrinking pool.
Good Luck and Good Trading.
 |
Print 
PDF
RSS Feed
