Is Buying Low and Selling High Possible in America Anymore?
Paris’ ritzy Place Vendôme is a nice place to shop, but it’s not a cheap place to shop. It offers top-quality goods at premium prices. New York’s Wall Street is no different.
The stocks on display there are as richly priced as a Louis Vuitton handbag. So if you’re hoping to find a bargain, you may have to look elsewhere.
According to the pervasive narrative, U.S. stocks are hitting record highs because earnings growth is strong. Unfortunately, this feel-good narrative ignores one important fact: the S&P 500’s earnings per share (EPS) are lower today than they were three years ago.
In September 2014, the S&P’s trailing 12-month EPS topped $ 113. Today, the S&P’s earnings are still below that number. And yet, despite this earnings nongrowth, the S&P 500 Index has advanced 30% since then.
In other words, U.S. stocks have simply become more expensive during the last three years, not more valuable.
The earnings trend looks a little better if we begin the analysis five years ago, instead of three. Since June 2012, the S&P’s earnings per share have increased about 16%. That’s not bad. But that result doesn’t come close to matching the S&P’s 107% price gain over that time frame.
You read that correctly… Stock prices more than doubled while earnings increased only 16%. A trend like this is called “multiple expansion” because investors pay an ever-expanding price multiple for each dollar of earnings.
In the specific case of the S&P 500 Index, investors paid about 14 times the index’s earnings in 2012. But today, that multiple has expanded to more than 21 times earnings.
One major cause of the S&P 500’s spectacular gain during the last few years has been the even more spectacular gains of these five stock market darlings: Facebook (Nasdaq: FB), Amazon (Nasdaq: AMZN), Apple (Nasdaq: AAPL), Netflix (Nasdaq: NFLX) and Alphabet (Nasdaq: GOOG) – the stock formerly known as Google.
These five stocks, like Sherpas on an ascent to Everest, have been carrying a big part of the load during the S&P’s climb toward record highs.
As the far left side of the below chart shows, the combined stock market gains of these five stocks contributed to about 10% of the S&P 500’s total three-year gain through May 2015. Over the ensuing two years, that percentage continued to rise to almost 50%.
In other words, during the last three years, the stock market gains of Facebook, Amazon, Apple, Netflix and Alphabet produced nearly half of the S&P 500’s total gain during that time.
But now what?
These five stocks cannot compensate for the other 495 stocks in the S&P 500 forever. As mighty as they are, they cannot carry the world. But even if they do manage to carry the index for several more months, better investment opportunities beckon elsewhere around the globe.
As the chart below shows, the S&P 500 is trading at 37-year highs, based on its price-to-EBITDA valuation (i.e., gross earnings). This nosebleed valuation is 43% higher than the valuation of non-U.S. stocks, as represented by the MSCI EAFE Index.
Clearly, the average U.S. stock is not on the bargain counter. That doesn’t mean it’s impossible to find compelling U.S. stocks to buy… but it is difficult.
If you’re hoping to find a nice cashmere sweater or bottle of wine at a good price, you don’t begin your search by perusing the lobby shops of a five-star hotel. You go to wherever the bargains may be found.
The search for good stocks is no different.
The U.S. stock market carries a five-star valuation, even though its earnings growth deserves no better than a two-star rating. So it’s probably time to do a little shopping elsewhere for investment opportunities.
It’s time to seek out the markets and sectors that are offering that rare and enticing combination of strong growth prospects and low valuations.
