10/14/2016
Are Stock Valuations Nearing Tech Bubble Levels?

Are Stock Valuations Nearing Tech Bubble Levels?

The stock market is getting pricier, and analysts at Bank of America Merrill Lynch are advising caution as many stocks are reaching valuations not seen since the tech bubble in the late 1990s.

Stock Valuations
The most common way to measure value in the stock market is by taking a stock’s price and dividing by its per-share earnings. The resulting number is known as the price/earnings ratio, or P/E ratio. When the P/E ratio is above average, stocks are said to be expensive. When the ratio is below average, predictably, stocks are said to be cheap.

Many analysts have noted that the average P/Es for stocks in the S&P 500 are much higher than their five- and ten-year long-term averages, but those averages are not yet at levels seen during recent bubbles.

Median P/Es, however, tell a far more daunting story.

Average P/Es vs Median P/Es
Savita Subramanian is a Managing Director and Head of United States Equity and Quantitative Strategy in Global Macro Research at Bank of America Merrill Lynch. She says the S&P 500 median P/E is presently at its highest levels seen since 2001, suggesting that the average stock is trading a full multiple-point higher that the oft-quoted aggregate P/E. It currently sits in the 91st percentile of its history, just 14% from its peak during the tech bubble.

The disparity between the average, or mean, P/E and the median, or midpoint, P/E can be explained by the sizable quantity of stocks with elevated valuations. During the tech bubble, a relatively limited number of stocks with massive valuations skewed the mean upward.

Subramanian offered more insight, explaining that the elevated stock valuations in the S&P 500 are driven primarily by the mid-caps. Mid-caps are companies with market capitalization between $2 billion and $10 billion. The median mid-cap stock is trading in the 92nd percentile of its history. The mega-caps, or companies with a market capitalization over $100 billion, are trading well below their valuations of the tech bubble era and are keeping the S&P 500 aggregate forward P/E below its tech bubble levels. In 2001, the 20 largest stocks were trading at a median P/E of 25x, while today the 20 largest trade at just 17x, she says.

These figures become more troubling when presuming the forecasts for forward earnings will decline. That assumption is exactly what Subramanian and her peers warn of, and if earnings estimates come down without a matching slide in stock prices, valuations will only go higher.

The stock market can be a tricky beast, but knowledgeable professionals can keep you ahead of the crowd and tailor your wealth plan to the goals you and your family set.

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