Looking at the stock market today, you'll find major market benchmarks like the Dow and S&P 500 trading at all-time highs. That has many investors reluctant to get into the market, fearing that they're paying too much for stocks. But just because the market is setting records doesn't mean that value investors have to give up on stocks entirely. In fact, by some measures, today's stock market is quite reasonably priced.
Looking at market multiples
Fundamentally, what determines a stock's value is what the company expects to earn in the future. When earnings prospects are good and growth appears strong, investors are willing to pay higher multiples to current earnings in order to buy shares. When future earnings become more uncertain, then shareholders aren't willing to pay as much today for what could be slower growth tomorrow.
With the Dow and S&P having soared between 125% and 140% since their 2009 lows, it'd be reasonable to assume that their earnings valuations would be somewhat lofty right now. But that's far from the case:
As you can see, multiples based on operating earnings are fairly low compared to their historical levels, and the recent run-up in stocks hasn't lifted those multiples as much as you might expect. Moreover, when you look at earnings as reported rather than operating earnings, the effect is even more pronounced due to the plunge in earnings during the financial crisis in 2008 and 2009.
Not all analysts think you should look at quarterly multiples in isolation like this. Economist Robert Shiller, for instance, has championed the use of the cyclically adjusted price-to-earnings ratio, which looks back at earnings over the past decade to come up with an average earnings figure that smooths out short-term changes. Whether that's appropriate for valuing stocks today, though, depends on whether you think future crises like we saw in 2008 are inevitable.
Finding bargain stocks
Even if you think the stock market today is overvalued, you can still find individual stocks that look much less expensive. Energy stocks in general carry relatively low multiples, reflecting concerns about future production and oil and gas prices. Yet even while some large oil companies have struggled, Chevron (NYSE:CVX) has been more successful than most at finding ways to seek production growth through a combination of aggressive and opportunistic asset purchases along with new discoveries in key areas like Australia and the ultradeep zone of the Gulf of Mexico. Similarly, ConocoPhillips (NYSE:COP) has identified the Canadian oil sands as well as the U.K. and Norway as being major contributors to production growth in the coming years. Both companies have P/E ratios in the 9 to 11 range.
Meanwhile, even the soaring financial sector remains full of interesting valuation plays. JPMorgan Chase (NYSE:JPM) has been under fire for leadership issues lately, but with its earnings multiple of less than 9, investors aren't giving the bank much credit for the earnings recovery it's been able to manufacture in recent years. Similarly, Wells Fargo (NYSE:WFC) will have to deal with the potential slowdown in mortgage activity and its effect on its bottom line, but a P/E of 10.9 looks attractive even if earnings growth gets more sluggish.
Don't wait until tomorrow
If you've been thinking about investing in the stock market, today is a good time to take a closer look at potential investments. Despite record highs, the market isn't as expensive right now as you think, and it still offers opportunities that you shouldn't miss out on.
Tune in every Monday and Wednesday for Dan's columns on retirement, investing, and personal finance. You can follow him on Twitter @DanCaplinger.
Fool contributor Dan Caplinger owns warrants on JPMorgan and Wells Fargo. The Motley Fool recommends Chevron and Wells Fargo. The Motley Fool owns shares of JPMorgan Chase and Wells Fargo. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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