Is the S&P 500 Overvalued?


Shutterstock photo

The S&P 500's current P/E is 21.5 and its Shiller P/E or CAPE (cyclically adjusted P/E) is 24.66. Both numbers are well above their respective historical averages and widely cited, in particular the Shiller PE, as proof the S&P 500 is overvalued. Even the forward-looking forward P/E of the S&P 500 is above average. It's currently 15.7 versus a 10-year average of 14.2. Earnings are also going the wrong way. With 96% of companies reporting so far, earnings have declined 3.3% this quarter. You have above average valuations and falling profits.

By pretty much any measure the stock market looks overvalued, so that should be the end of this article, right? Well, I'm not so sure. As with most things the devil is in the details, and I think that when you look under the hood, the S&P 500 might not look so overvalued after all. In particular I want to focus on how the commodities crash and foreign exchange rates have affected the numbers.

The commodity price crash

The commodity crash, in particular the drop in the price of oil, has had a large affect on the S&P 500's reported earnings. As of this writing, energy and materials companies make up 6.6% and 2.8% of the weight of the S&P 500. As you can see in the graphic below from FactSet, it's these two sectors that account for the bulk of the decline in earnings for the S&P 500.

While those two sectors don't make up a large portion of the S&P 500 the sheer magnitude of the drop in earnings (driven in part by accounting write-down's of assets, more on that later) is enough to drag down the entire index. In fact, if you excluded the energy sector, earnings would have risen 2.6% rather than falling 3.3%.

The other important thing to remember is that some of the decline in reported earnings for the energy sector is due to the write down of the book value of assets and not a reduction in cash earnings. Although make no mistake there is quite a large reduction in earnings as well! I was unable to find exact data on the breakdown of how much of the reported drop in profits was due to write downs.

I did take a look at several major energy companies and found accounting write downs accounted for around 25% to 50% of the drop in earnings. According to CFO Magazine , the energy sector wrote down $5.8 billion in assets in 2014 and was expected to write down a total of at least $50 billion in 2015. In addition, that's from November 2015 when oil was up in the mid $40 per barrel range.

It's these non cash accounting charges that are causing a large portion of the reported drop in earnings and thus depressing the "E" part of the S&P 500's reported P/E ratio.

Foreign exchange impact

The other big item weighing on corporate earnings is the strength of the dollar. While the U.S.


Warning! GuruFocus has detected 3 Warning Signs with LRCX. Click here to check it out.
LRCX 15-Year Financial Data
The intrinsic value of LRCX
Peter Lynch Chart of LRCX
Warning! GuruFocus has detected 4 Warning Signs with DYN. Click here to check it out.
DYN 15-Year Financial Data
The intrinsic value of DYN
Peter Lynch Chart of DYN
Warning! GuruFocus has detected 3 Warning Signs with PPL. Click here to check it out.
PPL 15-Year Financial Data
The intrinsic value of PPL
Peter Lynch Chart of PPL
Warning! GuruFocus has detected 3 Warning Signs with PPL. Click here to check it out.
STCK 15-Year Financial Data
The intrinsic value of STCK
Peter Lynch Chart of STCK
Warning! GuruFocus has detected 3 Warning Signs with PPL. Click here to check it out.
SPY 15-Year Financial Data
The intrinsic value of SPY
Peter Lynch Chart of SPY


Read More:
About GuruFocus: GuruFocus.com tracks the stocks picks and portfolio holdings of the world's best investors. This value investing site offers stock screeners and valuation tools. And publishes daily articles tracking the latest moves of the world's best investors. GuruFocus also provides promising stock ideas in 3 monthly newsletters sent to Premium Members .

This article first appeared on GuruFocus .

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.



This article appears in: Investing , Stocks
Referenced Symbols: SPY , XOM , AA , DAL , KO


More from GuruFocus

Subscribe






GuruFocus
Contributor:

GuruFocus

Stock Picks, Portfolios
Follow on:

Find a Credit Card

Select a credit card product by:
Select an offer:
Search
Data Provided by BankRate.com