I try and make it a point to know the valuations of the market at all times. But does a lower than average valuation mean something is cheap? This is a question that many analysts are paid a lot of money to figure out. Let’s take a look at the market to see if we can shed some light on the subject.
First of all, I would like to say that just because something has a lower valuation, it doesn’t necessarily mean it is cheaper. The word “cheap” implies something is undervalued and is primed to rise, but as we have seen many times in history, cheap markets and stocks can get a lot cheaper before anybody makes money from them.
That being said, I think there are strong pockets of value in the market and long term investors might do well to begin examining certain stocks. I recently said that it wasn’t time to start picking individual stocks, but everybody should be ready with a shopping list once things improve.
I did some calculations and found that the S&P 500 is trading at 12.1x forward estimates, depending on whose numbers you trust. These estimates seemed conservative so I used those in my calculations. Similarly, the Dow is trading around 11x forward estimates, which is quite reasonable. I like stable large caps in this environment and many are attractively valued and should hold up better than other more expensive growth names should the downdraft continue.
The problem is that another recession could cut the earnings estimates for these indices and many stocks, so investors are not sure how reliable these estimates are. I think if you focus on cheap, large caps with lots of cash and stable businesses, you will do just fine with their low valuations and margins of safety.
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