Recent volatility in the primary stock markets has changed the valuation landscape quite a bit. It was not too long ago that people were talking about stock market bubbles and massive overvaluation. Personally, I have felt that much of the concerns about overvaluation were exaggerated. I want to be clear, I did believe that the market was technically overvalued, and for the most part I still do. However, the difference between me and other pundits was a matter of degree.
At the end of September 2013, the stock market as represented by the S&P 500 had, in my opinion, moved from being undervalued since 2011 to becoming fairly valued. However, since that time I believe the market has moved into overvaluation territory. On the other hand, I did not feel that valuations were extreme, I just felt they were moderately high.
In my experience, stock valuations inevitably move back into alignment with fair value at some point. Sometimes this occurs quickly, and at other times it takes a little longer. I believe this is based on the reality that the stock market is constantly seeking efficiency. However, that does not mean that the market is always efficient. Instead, it means that the market can become inefficient at times, but will inevitably move towards more sound valuations in the long run.
Importantly, what I just said is not necessarily a market timing principle. This is true because as I previously stated, sometimes prices can move to fair valuation quickly and sometimes it takes a lot longer. Moreover, just as stocks can become overvalued, they can also become undervalued. Therefore, the fact that the market is always seeking efficiency is more about risk than it is about timing. In other words, high valuations indicate greater risk while low valuations indicate less risk.
In concert with the level of valuation risk you’re taking is the reality that it will have a significant impact on long-term returns. In the short run, you can invest in a stock at a high valuation and it can continue to run and make you money for months or even years. However, the longer you hold onto an overvalued stock the lower your chances are of making money, and the greater your chances are of losing money.
Additionally, as I hope most of you know, I believe it is a market of stocks and not a stock market. Consequently, every market will contain fairly valued, overvalued and even undervalued individual companies (stocks). Until recently, I have been finding it very difficult to find fairly valued or undervalued investment opportunities. However, the recent stock market correction has changed the landscape quite a bit.
I am currently in the process of updating the fairly valued research candidate portfolios for September. Several of them are already updated, and I am working on updating the rest. You can tell which ones are finished by looking at the dates preceding the portfolio titles. The updated portfolios are dated 2015.09. Several names have been added to the Dividend Challengers, Champions and Contenders.
I want to be clear that these updates are primarily valuation driven. Furthermore, I have not thoroughly researched all of the additions or the existing candidates. However, I do believe that each of the names on the portfolios is at the very least attractively valued currently. I leave it up to each of you to pick and choose in order to find opportunities that meet your own goals and objectives.
The analyze-out-loud video associated with this article will review the current valuation of the S&P 500 and present a few examples of companies that have recently come into value. Although the lists are getting bigger, I caution each of you that the markets are currently very volatile.