Is the Market Too High?

In 1990 Michael Jordan set a personal single game record by scoring 69 points against the Cavaliers. After the game, rookie Stacey King, who had scored a single point said, “I will always remember this as the game when Michael Jordan and I combined for 70 points.” That quote came to mind when an investor asked me, “Do you think the stock market has gone too high?”

Over the past year the stock market averages regularly hit new records though much of the gains could be attributed to a handful of very large high-tech companies. Those high-flying stock prices often overshadowed the dismal numbers from many other public companies. As their prices went up, so likewise did their price to earnings ratio, or PE.

PE is a traditional method for valuing stocks, and historical averages have usually been in the 15 to 20 times earnings range. So, if a company earns a dollar a year for example, you might expect its stock to be selling between $15 and $20. Purely for comparisons sake I looked up the PE ratio for TESLA on the day of this writing and it stood at an astronomical 1162 to 1. Analysts may debate whether TESLA is worth 1162 times its earnings, but one thing is clear. Much like Michael Jordan’s big game, when you average TESLA and other similar high priced tech stocks with the rest of the market, the overall PE average can become quite skewed. This can distort the impression of how the market is doing.

So back to whether the market, and the associated PE ratios, have gone too high. I would suggest that the best way to view the current market is on a case-by-case basis. Though King and Jordan averaged 35 points between them, neither one actually scored anywhere near that number. I am seeing the same disconnect in current stock prices. The averages don’t tell the story.

In our company investment meeting today my son Jayden, a new intern at our firm, asked how he could begin learning how to select good investment opportunities. I told him an easy place to start is to ask himself what products or services people stopped using last year because of Covid, that they would return to using in the coming year as things open up again. In his response he named many economic sectors and businesses that one might say only scored a point or two last year but in the coming years could do much better.

It is true that market averages and PE ratios as an average are very high. But it is also true that the market had a few Michael Jordans’ last year who greatly distorted the averages and hid the fact that many businesses are still yet to recover. Investors might want to pay more attention to finding those companies, the “Stacey Kings” one might say, who still have their best games ahead of them.