A timeless question investors always got to ask themselves is if the future returns from stock investment as an asset is large enough to make up for the risk they take by owning securities instead of bonds or just having money in the bank. Always remember that the reason stocks return more than safer options such as bonds is because in the long run, you are paid to endure more risk. However, that might not mean that a single stock will outperform a bond. But based upon historical data, putting money in stocks have been the absolute best way to grow your wealth.
So, what now? Look at the following graph. Where would you say we are now? Not long ago Bitcoin was at the “media attention” and “enthusiasm” state. It’s hard to say if Bitcoin or other cryptocurrencies have peaked or not, so let’s go straight to discussing stocks.
Surely, market participants have favored growth stocks over value stocks in the past years. The market’s forward P/E ratio is 16.1, which is in line with its 5-year average (2013-2018). The 10-year average is around 14.3. Already here, it’s smart to keep in mind that the market peaked at 2007, dropped like a stone in 2008, and almost fully recovered in 2009/2010, so a ”fair” 5-year average might not be so positive after all. At least not meaning that future returns from equites are very promising. But the forward P/E is down from 18.2, which at least is something to be happy about.
From 1950, the S&P500 has dropped 21 times from ATH, with an average decline at 21% and a typical recovery at 1.7 years. So, if one needs money within now and two years, selling now might not be the worst idea.
The Fed increased interest rates by 0.25% and wants to increase another two times this year. As we know, higher interest rates puts a pressure on stocks and bonds, and especially equites paying high dividends with high debt / leverage.
Sector wise, technology has killed it. The 5-year return is 140% and 1 year return is 24.1%. Many companies operate with P/E levels close to 20-40, maybe even 50. The combination of tax-reduction (most of the top 50 companies with cash overseas are tech-companies), a general favor for growth and increased earnings have pushed these stocks at insane prices. Or are they?
The P/E ratio as well as the P/S are easy to understand, but it’s hard to use when we are talking about growth. Take Amazon, P/E is 300 and forward P/E is 90. How on earth can one find value here? It’s a matter of the model you use. Classic fundamental valuation would say no at once, but if one uses a different approach, Amazon wasn’t priced bad at all at $800 – $1000. By taking the enterprise value and dividing it by the sales, one could show that Amazon, which has growing sales at 20% annually, was priced at a smaller percentage of sales than were average brick-and-mortar stores.
However, there is a lot of truth in P/E ratios and technology is certainly not very cheap. On the other hand, we have the energy sector which is only up 8% during the last 5 years, which is a -103% relative return to the S&P500. Many utilities such as SO, D, DUKE are now trading at prices which seems to be better than a bond investment, even though interest goes up.
On an annualized basis, we can expect something like 4-8% now, and we have bonds and free saving accounts providing 2% for free. Meaning, that the risk/reward is something to consider. If you only earn 2% more by taking a bunch of risk, then that’s a poor call. However, if you earn 6%, then that’s a pretty good call. Mathematically, we are probably closer to 4% than 8 %, unfortunately.
Every investor needs to figure out their risk-tolerance. Here at Library For Smart Investor we want to inform and make sure you have enough information to take a smart choice which is right for you.