High Times

Mike Zaccardi

READERS KNOW I LOVE my baseball. There’s an old unwritten rule that, when a pitcher is working a perfect game, nobody talks to him. The position players leave the hurler alone since he needs to be “in the zone.” Fans grow more nervous as the game progresses and the ninth inning draws near. With each passing out, the prized perfect game comes closer into view.

I’m getting the same antsy feeling when it comes to highflying tech stocks. Their valuations are through the roof based on most metrics. We’ve seen the Nasdaq commit a few “errors” this month, after seeming to pitching a perfect game from the March 23 market low through August, and folks are now wondering whether the great tech bull market is over.

To judge whether a stock is expensive or cheap, market analysts look to price-to-earnings and price-to-sales ratios. More in-depth valuation metrics include price-to-free cash flow and enterprise value-to-EBITDA, or earnings before interest, taxes, depreciation and amortization. Let’s take a moment to explore some of these gauges of market frothiness.

What’s a price-earnings (P/E) ratio? This is Finance 101 stuff. At the University of North Florida, here in Jacksonville, I teach P/Es during the first week of my security analysis class. It’s simply the price of the stock (or the level of a market index) divided by the company’s earnings per share (or the index’s aggregate earnings per share).

Today, the S&P 500 trades at a whopping 37 times the past 12 months’ reported earnings. The 100-year average trailing P/E ratio for the S&P 500 is just 17, so we’re at more than double the historical average. Meanwhile, the P/E ratio based on expected earnings for the next 12 months is 26, also high by historical standards.

Why have P/Es increased? The S&P 500 is up 3% this year, while corporate earnings per share are down 29% from their peak, according to data from S&P Global. You don’t need a PhD in finance to realize that when prices go up and earnings collapse, P/Es go to the moon. Still, other measures of market valuation also indicate that the stock market is expensive:

Price-to-sales. With this market gauge, instead of using earnings as the denominator, we use the past 12 months’ sales. The S&P 500 had sales per share of $1,372 over the 12 months through 2020’s second quarter. With the index at 3341, that means the price-to-sales ratio is around 2.4, a 60% premium to the 20-year average of 1.5.

Shiller P/E. Standard P/E ratios are criticized as being too sensitive to short-term fluctuations in corporate profits. The Shiller P/E avoids that pitfall by using average inflation-adjusted earnings for the past 10 years. This measure is also called the CAPE (cyclically adjusted price earnings) ratio or simply PE 10. It currently stands at 31, a 70% premium to the 100-year average of 18. The 30-year average is 26, which puts the current valuation premium at “just” 20%.

Price-to-book value. For this measure, analysts use stockholders’ equity, which is the value of a company’s assets—as carried on its books—minus all liabilities. Book value is stockholders’ equity figured on a per-share basis. The S&P 500 currently trades at around 3.8 times book value, or some 35% above the 20-year average of 2.8.

Tobin’s Q. This one is a little more obscure. It compares the stock market’s total value to the value of corporate assets—with those assets valued at replacement cost, rather than at how much companies paid for their assets. Today, stock prices are at 1.86 times corporate assets, versus a 120-year average of 0.78. For perspective, Tobin’s Q peaked at 2.14 in March 2000 and at 2.1 just before the COVID-19 crash. At the March 2009 market low, it touched 0.65, just below the long-term average.

The bottom line: By almost any measure, U.S. large-cap valuations are high. But keep in mind that this year’s first six months had a severe negative impact on sales and earnings. We may not get back to “normal” earnings until July and August of next year, when companies report 2021’s second quarter earnings. That means valuation measures will be somewhat distorted for at least the next year or so.

What should investors do? If you’re scared by the S&P 500’s valuation, look to beaten-down areas like small-cap shares, value stocks and foreign markets, where valuations are far more reasonable. Amazon, Apple, Facebook, Google (a.k.a. Alphabet) and Microsoft—the so-called FAAMG stocks—make up more than a fifth of the S&P 500’s market cap, so their sky-high valuations have a big impact on the index.

Is this March 2000 all over again? Are we in the ninth inning? Who knows? But it’s reasonable to think that returns might be weak over the next five or 10 years for mega-cap tech stocks, at least relative to other areas of the stock market. It’s been a hall-of-fame-worthy run for FAAMG. Maybe it’s time to make sure you have plenty of exposure to other areas of the global market.

Mike Zaccardi is a portfolio manager at an energy trading firm and a finance instructor at the University of North Florida. He also works as a consultant to financial advisors on an hourly basis, helping with portfolio analysis and financial planning. Mike is a Chartered Financial Analyst and Chartered Market Technician, and has passed the coursework for the Certified Financial Planner program. His previous articles include Ripple EffectsRaw Deal and Cooking Up a Story. Follow Mike on Twitter @MikeZaccardi, connect with him via LinkedIn and email him at

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