Is the Stock Market Overvalued?

Recently, the CEOs of Netflix (NASDAQ: NFLX) and Tesla Motors (NASDAQ: TSLA) explicitly and publicly warned shareholders that their stocks look frothy. With price-to-forward earnings ratios of 102 and 170, respectively, that should hardly come as a surprise to investors. But what of the broad market? Even after a 23.5% year-to-date rise, the S&P 500 (SNPINDEX: ^GSPC  )  trades at roughly 15 times estimated earnings per share for the next 12 months -- that hardly looks outrageous.

However, another valuation metric -- the Shiller P/E ratio, which uses an average inflation-adjusted earnings per share over a trailing 10-year period -- suggests the index is close to 50% overvalued by historical standards.

The Shiller P/E was popularized by Robert Shiller of Yale, who shared the Nobel Prize in Economics last month for showing that stock prices display some predictability over long periods of time, with valuation indicators (including the Shiller P/E) tending to fall when they are high, and increase when they are low. Right now, the Shiller P/E is roughly 50% above its long-term historical average.

In the following video, Motley Fool One analyst Morgan Housel and Fool contributor Alex Dumortier discuss how much weight investors ought to put on that metric in trying to answer a critical question: Are stocks overvalued?

The best time to start investing is now
Millions of Americans have waited on the sidelines since the market meltdown in 2008 and 2009, too scared to invest and put their money at further risk. Yet those who've stayed out of the market have missed out on huge gains and put their financial futures in jeopardy. In our brand-new special report, "Your Essential Guide to Start Investing Today," The Motley Fool's personal finance experts show you why investing is so important and what you need to do to get started. Click here to get your copy today -- it's absolutely free.


Read/Post Comments (0) | Recommend This Article (1)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

Be the first one to comment on this article.

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 2712705, ~/Articles/ArticleHandler.aspx, 10/31/2014 4:04:55 AM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...


Advertisement