Stocks have been rising for a very long time now. If you don’t count the short bear market of spring 2020, then they have been rising for 11 and a half years straight. That’s a very long bull market. In fact, it may be the longest in history, which is why many market prognosticators are now calling for a stock market crash. What goes up must come down eventually, and the current bull market seems long in the tooth.
Nevertheless, the odds of a near-term stock market crash are not that high. Although stocks have risen, their valuations have actually declined. Thanks to a string of solid earnings releases, the S&P/TSX 500 Composite Index’s P/E ratio has come down. So while stocks are more expensive in price, they’re actually cheaper relative to fundamentals.
S&P 500 P/E ratio DECLINES!
For most of the past year, the S&P 500’s P/E ratio has been hovering around 35. That’s a historically high ratio, and one of the reasons why many people think the market is set for a crash. Indeed, 35 is the highest S&P 500 P/E ratio since the 2008/2009 financial crisis. However, the ratio has actually declined in recent months. America’s big tech companies released earnings this past October, and they all increased significantly year over year. As a result, the S&P 500 P/E ratio is now down to 29 according to multpl.com. That’s still a pretty high multiple, but it’s much lower than at many points in the past.
What this means for Canadian investors
As we’ve seen, U.S. stocks are getting cheaper relative to earnings. That looks bullish for U.S. equities, but what about Canadian stocks? Market P/E ratios aren’t so readily available for Canada as they are for the United States, so this analysis is a little harder to apply here.
Nevertheless, there are some clues we can look to to see where things are headed.
One thing to look at is the multiples of heavily weighted TSX stocks. These stocks can tell us where things are headed because they represent a large share of the TSX index.
One stock we can look at is Shopify (TSX:SHOP)(NYSE:SHOP). It’s a pretty expensive stock, trading at 45 times sales, 230 times adjusted earnings, and 56 times GAAP earnings. That’s pricey, but some of these multiples are down. The GAAP P/E ratio, for example, was 73 just weeks ago. When SHOP’s third-quarter earnings came out, GAAP earnings came in way above expectations, at $9. That was due to massive gains in the company’s investment portfolio. The gains were unrealized but did result in high earnings in GAAP terms. The end result was Shopify stock arguably becoming cheaper despite big increases in the stock price.
We can also look at bank stocks like the Toronto-Dominion Bank (TSX:TD)(NYSE:TD). These stocks also have a heavy weighting in the TSX. And they’re extremely cheap right now. At today’s prices, TD trades at around 10 times earnings. With a multiple like that, you’d think it’s a dying company. Yet it actually has a five-year compound annual growth rate earnings growth rate of 13.1%. So when you buy it, you get a decent combination of growth and value in one package.
