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Real Time Insight

I hate to be the one to bring this up, especially since I am such a raging bull.

But apparently, "historical P/E multiple" is a very abused description. It's all about the data you use says Goldman Sachs equity strategist David Kostin.

Kostin issued a report over the weekend to explain why the market is so pricey, chock full of graphs and tables that help visualize it. But his words below do a great job of getting the point across...

"The current valuation of the S&P 500 is lofty by almost any measure, both for the aggregate market as well as the median stock: (1) The P/E ratio; (2) the current P/E expansion cycle; (3) EV/Sales; (4) EV/EBITDA; (5) Free Cash Flow yield; (6) Price/Book as well as the ROE and P/B relationship; and compared with the levels of (6) inflation; (7) nominal 10-year Treasury yields; and (8) real interest rates. Furthermore, the cyclically-adjusted P/E ratio suggests the S&P 500 is currently 30% overvalued in terms of (9) Operating EPS and (10) about 45% overvalued using As Reported earnings.

Reflecting on our recent client visits and conversations, the biggest surprise is how many investors expect the forward P/E multiple to expand to 17x or 18x. For some reason, many market participants believe the P/E multiple has a long-term average of 15x and therefore expansion to 17-18x seems reasonable. But the common perception is wrong.

The forward P/E ratio for the S&P 500 during the past 5-year, 10-year, and 35- year periods has averaged 13.2x, 14.1x, and 13.0x, respectively. At 15.9x, the current aggregate forward P/E multiple is high by historical standards.

Most investors are surprised to learn that since 1976 the S&P 500 P/E multiple has only exceeded 17x during the 1997-2000 Tech Bubble and a brief four-month period in 2003-04. Other than those two episodes, the US stock market has never traded at a P/E of 17x or above."

I bolded the section that stood out most to me. "But the common perception is wrong," says Kostin. Maybe I need to reevaluate my ideas that this market can easily push to a 17-18 multiple. But I still think it will because enough conditions are right for, dare I say it, this time to be (slightly) different and poke its head above 17X.

So my question is this: How will the momentum multiple expansion continue to win the day in the short-run (3-6 months) and override long-run valuation concerns?

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