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Monday, January 25, 2016

Are Stocks Cheap? Checking in on Current Valuations

I'll leave it to others to chime in whether forward P/E's are useful or not given the fact they typically overstate earnings and I'll ignore that earnings may be at a cyclical peak (more on the latter here). As an aside, technicals in the market are filthy, as most short-term signals I look at are providing caution (example here). BUT, based purely on current forward P/E's relative to their own history, both large growth and large value stocks look awfully attractive if you are of the belief that the recent market noise is just noise vs. a sign of recession.

How attractive?

The below chart plots all quarterly forward P/Es against the forward 5-year annualized returns of both indices going back to the 1979 Russell inception of each. As of January 15th, the forward P/E of large value breached 14x while large growth went sub 17x, both historically great valuations to be buying at for the longer-term.


Highlights include that the average forward 5-year annualized returns of large value / growth were 13.9% / 16.1% when the P/E was below current levels and only 7.6% and 5.5% when above (and growth has never had a negative 5-year return when the forward P/E was this low).