Episode summary
Stocks Are Cheaper Than You Think - It All Depends On What You Measure
Summary
The host argues that U.S. stocks may not be as expensive as they look, but that the answer depends heavily on which valuation measure you use. Trailing 12-month P/E is 25.4, while the Shiller CAPE is 40.6, and the gap comes from the recent surge in earnings and the way CAPE smooths over a decade of inflation-adjusted profits. The host says U.S. earnings per share have risen 61% over the past year, which has made the market look cheaper on a trailing basis even as it looks extreme on a long-term basis.
A key part of the argument is that record profit margins are doing much of the work. The host says margins are at or near record highs because worker compensation has not kept pace with productivity, allowing more value to flow to corporate profits. That helps explain why forward P/E looks high at 19.4, yet becomes much less alarming when adjusted for margins. But the same setup also pushes price-to-sales to a record high, and it leaves the market dependent on whether margins keep expanding.
The host also emphasizes concentration risk: the top 10 U.S. stocks make up 41% of the market and 36% of earnings. He says the market’s future likely hinges on AI-driven productivity and whether those gains accrue to companies or to workers. To reduce U.S. concentration, he says he is underweight U.S. stocks, favoring non-U.S. equities and small caps, while also seeing value in TIPS yielding over 2% in real terms.
Key takeaways
- The host says the choice between trailing P/E and CAPE changes the valuation story because earnings have surged sharply over the past year.
- Record profit margins are central to the bullish case, but the host says they depend on workers not reclaiming more of the value created.
- The host says the S&P 500’s top 10 names now account for 41% of market value and 36% of earnings, increasing concentration risk.
- A forward P/E of 19.4 looks less expensive when divided by a 13.3% margin, but that same setup implies record price-to-sales.
- The host says he is underweight U.S. stocks and prefers non-U.S. stocks, small caps, and TIPS yielding over 2% in real terms.
Notable quotes
“Maybe US stocks aren't as expensive as we think. And everything's going to be fine that current valuations are justified”
“One is based on trailing 12-month earnings and that's at 25.4. The other is the Shiller PE or the cyclically adjusted price to earnings ratio. That's at 40.6”
“Just just astounding earnings growth, and because it's been so strong, again, that has lowered the trailing 12-month price-to-earnings ratio”
“Their their their profit margins, what their earnings are compared to sales is really the highest since 1961”
“41% of the US stock market is made up of the top 10 companies”
How the episode opens
Here's a thought. Maybe US stocks aren't as expensive as we think. And everything's going to be fine that current valuations are justified.
That's a possibility and that's what we're going to look at in this bonus episode of Money for the Rest of Us. We're going to look at different stock market measures and really get down to the crux of what is driving this bull market that we're seeing, this AI driven bull market. But first, let's look at a couple of different ways to measure valuations of US stocks.
Here are two different versions of the price to earnings ratio. One is based on trailing 12-month earnings and that's at 25.4. The other is the Shiller PE or the cyclically adjusted price to earnings ratio.
That's at 40.6. That's higher. That's at the most one of the most expensive that it's ever been.
Whereas and you know, almost two standard standard deviations more expensive than average. Whereas the trailing PE is only one standard deviation more expensive than average. And so, why is it that the trailing PE isn't as expensive as the Shiller PE?
Well, it comes down to how the two are constructed. When we divide the price of the S&P 500 index by the earnings over the past year, that is more volatile where because the the Shiller PE, the CAPE ratio, takes the inflation adjusted earnings over the past decade. And so, it smooths it out.
It's really kind of compared to let's say you take a baseball player and you measure the productivity over one season versus over a decade. And so, when we look at the the CAPE ratio, it is more expensive because we're using a broader measure measure of earnings, real earnings over the past decade. The price we're paying is the same for for both in terms of the index level, but because earnings growth has been so strong over the past year for the US stock market, that has brought down the trailing 12-month price-to-earnings ratio.
From the episode’s captions: roughly the first two minutes, lightly cleaned. Keep watching on YouTube →
Topics
- u.s. stock valuations
- p/e ratios
- profit margins
- market concentration
- portfolio positioning
Watch the episode
Watch “Stocks Are Cheaper Than You Think - It All Depends On What You Measure” on YouTube
Summary, takeaways and quote selection by Octagon. Quotes are short excerpts; the full conversation is in the episode.
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Money For The Rest Of Us, this episode and its artwork belong to J. David Stein. Octagon is not affiliated with the show; this page is an independent summary.
