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Stock `Fundamentals' Make Investors Wary

CONCERNS about lower corporate earnings have rattled the United States stock market in recent days. Until now, the market has been setting new highs, with the Dow Jones industrial average hitting 3,554.83 points in late May. Many longtime market observers say that the market is overpriced and runs the risk of a downward "correction."

Based on such underlying market fundamentals as the ratio of the price of corporate stocks to the earnings of those companies, the level of dividends, and the market value of stocks compared with their book value, the market appears to be overvalued, says Joseph Tigue, managing editor of The Outlook, a monthly market review published by Standard & Poor's Corporation.

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In 1982, the S&P 500, a stock market index based on 500 companies, traded at eight times earnings, 1.1 times book value, and yielded 6 percent, Mr. Tigue says. That compares with 23 times earnings, 2.6 times book value, and a yield under 3 percent today.

The yardstick most commonly used to measure the market is the price-earnings (P/E) ratio. It measures how much investors will pay for a dollar's-worth of a company's earnings. There are different ways of measuring P/E ratios. Based on trailing 12-month earnings - looking backward to a company's actual earnings - the S&P 500's P/E is now more than 23, near the 1991 postwar high. Another way of measuring the P/E ratio is to look at US corporations' earnings projections. Based on those earnings projections,

the P/E is now at 19. Yet "in only three postwar years [1961, 1991, and 1992] has the P/E been above 20," Tigue says. The average P/E ratio for the S&P 500 from 1940 to 1992 was 13.

Two other yardsticks also suggest an overpriced market. The S&P 500 market-to-book-value ratio - a company's net worth on a per-share basis - is running above 2.5 percent, Tigue says. In the late 1970s the ratio was under 1.5 percent. It has inched upward since then, setting records in both 1991 and 1992 when the S&P 500 closed the year at 2.66 times book value.

The dividend yield continues to fall. A yield is a return on investment measured in percentages. A falling yield usually forecasts a market decline. Currently, the yield is running in the 2.8-percent range. Since 1926, it has fallen below this level only three times. In August 1987, just before the market crashed in October, the yield hit 2.64 percent; in January 1973 the yardstick fell to 2.65 percent before a major market correction; and it fell to 2.81 percent in December 1961 before another major cor rection. To put the yield into perspective: In October 1929, it stood at 2.88 percent before the market crash which was considered the beginning of the Great Depression.

Despite such relatively gloomy assessments, Tigue says, the current economic environment has a number of plusses that make the market far less threatening than market yardsticks alone suggest. The economy continues to grow, albeit slowly. And interest rates remain low, which is good for stocks.

The high valuation levels are leading to a reappraisal of how much exposure investors should have in equities. Glenmede Trust Company in Philadelphia, which manages $7.6 billion in assets, is one of many management companies slowly cutting back on the equity portion of its investment portfolio because of concerns about the economy's future course, the Clinton administration's economic policies, and high valuation levels.

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But since there are few lucrative alternatives to equities, "we're finding it difficult keeping equities at below 50 percent of our overall investment portfolio," says Nancy Smith, vice president and portfolio manager with Glenmede. The stock market will continue to rise this year with a modest correction possible, she says.

In a new outlook for stock-market performance, Salomon Brothers says that the market has a "slight downward bias," but it is not anticipating any major correction.

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