Breaking News
Investing Pro 0
NEW! Get Actionable Insights with InvestingPro+ Try 7 Days Free

S&P 500: The Dangerous Assumption Embedded In Current Valuations

By Jesse FelderStock MarketsAug 18, 2022 01:58AM ET
www.investing.com/analysis/sp-500-the-dangerous-assumption-embedded-in-current-valuations-200628670
S&P 500: The Dangerous Assumption Embedded In Current Valuations
By Jesse Felder   |  Aug 18, 2022 01:58AM ET
Saved. See Saved Items.
This article has already been saved in your Saved Items
 
 
US500
-1.51%
Add to/Remove from Watchlist
Add to Watchlist
Add Position

Position added successfully to:

Please name your holdings portfolio
 

Many investors like to use price-to-earnings ratios as a short-hand valuation tool for both individual equities and the broad stock market. Most of the time this can be useful but there are also times when it can be very misleading. Typically, those times are at the top or the bottom of the earnings cycle.

When earnings are unduly depressed due to recession or are over-inflated due to opposite economic circumstances, the denominator in the ratio is no longer representative of sustainable earnings potential. As a result the metric itself appears dramatically elevated at the bottom of the cycle or somewhat depressed at the top of the cycle, sending a false signal regarding value.

Today, the S&P 500 Index sports a price-to-earnings ratio of 21 on trailing 12-months’ operating earnings and 18 on analyst estimates of operating earnings over the next 12 months. Relative to the past five years, these levels are about average, leading many investors to the conclusion that stocks, after their decline so far this year, are now fairly valued.

S&P 500 Index Forward P/E Ratios Chart
S&P 500 Index Forward P/E Ratios Chart

However, it’s crucial to note that the profit margins underlying those earnings currently sit at their highest levels in decades (if not in history). Those price-to-earnings ratios then are only valuable to the extent that extremely elevated profit margins are sustainable. Because if profit margins fall, it will quickly become apparent that earnings were over-inflated and thus price-to-earnings ratios were misleadingly low.

S&P 500 Operating Margin
S&P 500 Operating Margin

As my friend, John Hussman, points out (and small businesses have been suggesting for months now) there is a compelling case to be made that this is precisely the case. Labor costs have been surging. Typically this puts a great deal of pressure on profit margins but it has not exerted its normal effect as of yet thanks to massive pandemic subsidies. Going forward, though, it’s likely this relationship reasserts itself and profit margins normalize, a risk today’s price-to-earnings ratios don’t reflect.

S&P 500: The Dangerous Assumption Embedded In Current Valuations
 

Related Articles

Jesse Cohen/Investing.com
Expect A Wild October By Jesse Cohen/Investing.com - Sep 30, 2022 11

October is historically the U.S. stock market’s most volatile month Market focus on nonfarm payrolls report, CPI, Q3 earnings Brace for more violent swings in the coming...

S&P 500: The Dangerous Assumption Embedded In Current Valuations

Add a Comment

Comment Guidelines

We encourage you to use comments to engage with other users, share your perspective and ask questions of authors and each other. However, in order to maintain the high level of discourse we’ve all come to value and expect, please keep the following criteria in mind:  

  •            Enrich the conversation, don’t trash it.

  •           Stay focused and on track. Only post material that’s relevant to the topic being discussed. 

  •           Be respectful. Even negative opinions can be framed positively and diplomatically. Avoid profanity, slander or personal attacks directed at an author or another user. Racism, sexism and other forms of discrimination will not be tolerated.

  • Use standard writing style. Include punctuation and upper and lower cases. Comments that are written in all caps and contain excessive use of symbols will be removed.
  • NOTE: Spam and/or promotional messages and comments containing links will be removed. Phone numbers, email addresses, links to personal or business websites, Skype/Telegram/WhatsApp etc. addresses (including links to groups) will also be removed; self-promotional material or business-related solicitations or PR (ie, contact me for signals/advice etc.), and/or any other comment that contains personal contact specifcs or advertising will be removed as well. In addition, any of the above-mentioned violations may result in suspension of your account.
  • Doxxing. We do not allow any sharing of private or personal contact or other information about any individual or organization. This will result in immediate suspension of the commentor and his or her account.
  • Don’t monopolize the conversation. We appreciate passion and conviction, but we also strongly believe in giving everyone a chance to air their point of view. Therefore, in addition to civil interaction, we expect commenters to offer their opinions succinctly and thoughtfully, but not so repeatedly that others are annoyed or offended. If we receive complaints about individuals who take over a thread or forum, we reserve the right to ban them from the site, without recourse.
  • Only English comments will be allowed.

Perpetrators of spam or abuse will be deleted from the site and prohibited from future registration at Investing.com’s discretion.

Write your thoughts here
 
Are you sure you want to delete this chart?
 
Post
Post also to:
 
Replace the attached chart with a new chart ?
1000
Your ability to comment is currently suspended due to negative user reports. Your status will be reviewed by our moderators.
Please wait a minute before you try to comment again.
Thanks for your comment. Please note that all comments are pending until approved by our moderators. It may therefore take some time before it appears on our website.
Comments (3)
ajit choudhary
ajit choudhary Aug 18, 2022 4:06AM ET
Saved. See Saved Items.
This comment has already been saved in your Saved Items
Buy dax index current pricestoploss 13627
ajit choudhary
ajit choudhary Aug 18, 2022 4:06AM ET
Saved. See Saved Items.
This comment has already been saved in your Saved Items
Buy dax index current pricestoploss 13627
Hunt Richardson
Hunt Richardson Aug 18, 2022 2:25AM ET
Saved. See Saved Items.
This comment has already been saved in your Saved Items
straightforward idea. will consumers continue to spend more? that is the big question now
 
Are you sure you want to delete this chart?
 
Post
 
Replace the attached chart with a new chart ?
1000
Your ability to comment is currently suspended due to negative user reports. Your status will be reviewed by our moderators.
Please wait a minute before you try to comment again.
Add Chart to Comment
Confirm Block

Are you sure you want to block %USER_NAME%?

By doing so, you and %USER_NAME% will not be able to see any of each other's Investing.com's posts.

%USER_NAME% was successfully added to your Block List

Since you’ve just unblocked this person, you must wait 48 hours before renewing the block.

Report this comment

I feel that this comment is:

Comment flagged

Thank You!

Your report has been sent to our moderators for review
Continue with Google
or
Sign up with Email