ARE STOCKS WORTH THEIR PRICE? / THE WALL STREET JOURNAL

Are Stocks Worth Their Price?

Warren Buffett has struggled to find companies to buy. Value-minded investors looking at the stock market can relate.

By Justin Lahart

In his annual letter to shareholders, published on Saturday, the chief executive of Berkshire Hathaway said his quest for a large acquisition has continued to come up short. “Prices are sky-high for businesses possessing decent long-term prospects,” he complained.

Mr. Buffett is hamstrung in part because he has more than $100 billion in cash to put to work. Unable to find what he called an elephant-sized acquisition, he said Berkshire would likely be expanding its portfolio of stocks instead. Considering where valuations are, even that hunt for smaller game could be trying.

Start with how stocks stack up against expected earnings. A year ago, the S&P 500 traded at 17.1 times what analysts thought its underlying companies would earn over the next 12 months, according to FactSet. Now, that forward price/earnings ratio is about 16.2. That is right around the average of 16 for the 23 years for which FactSet has data.

But 23 years doesn’t count as a lot of history. And since it is for is a period that includes both the nose-bleed valuations of the dot-com bubble and the deep discounts that came after the financial crisis, it is hard to say what the right forward P/E should be.


Warren Buffett’s Berkshire Hathaway is hamstrung in part because it has more than $100 billion in cash to put to work. Photo: rick wilking/Reuters


Investors also can look backwards using trailing P/Es—what stocks fetch relative to earnings already in the books rather than what analysts were projecting. One popular way of doing that is the “cyclically adjusted price-earnings,” or CAPE ratio, that economists Robert Shiller and John Campbell came up with in the late 1990s. This looks at stock prices versus the past 10 years of earnings, smoothing out the effects of economic booms and busts and adjusting for inflation. 

Today the CAPE is at around 30, which compares to with an average of about 20 over the past half century—in other words, quite expensive. But the CAPE may overstate how pricey stocks are. First, it still reflects (but soon won’t) large write-downs from the financial crisis a decade ago. Second, it reflects a different tax regime. Through the first three quarters of last year, the corporate tax cut boosted the earnings measure the CAPE relies on by about 11%, according to Zion Research Group. If last year’s tax cut had prevailed over the past decade, the CAPE would be about three points lower.

To avoid the impact of the tax cut, and also the question of whether tax laws will be changed again, investors could look at a valuation measure Mr. Buffett has pointed to: The market capitalization of U.S. stocks as a percentage of gross national product. Right now, that measure stands at about 159% which isn’t far from the 171% it hit during the dot-com bubble.

Of course no single measure can really capture how under or overvalued the stock market might be—there are too many moving parts. But looking across a variety of them suggests the market is hardly a bargain. Some individual stocks almost certainly are, but for both Mr. Buffett and regular investors, identifying them is no easy task.