Looking for good values while shopping this month? Surprisingly, there’s still value in the stock market.
The Dow Jones Industrial Average, at just below 18,000, is near its all-time high. The broader S&P 500 index is also near its peak, up more than 10 percent just since summer.
Are the current prices of these stocks right? There is no way to know for certain. Economic theory and practice direct us to the next best alternative, or opportunity.
A common estimate of a stock’s expected return, popularized long ago by legendary investor Benjamin Graham, is found by comparing the net income of the company to the price of its stock. This rate is the inverse of a stock’s price-to-earnings, or PE, ratio.
At current prices the average U.S. stock has a PE ratio of 23, or an earnings yield of 4.3 percent. So, what is the opportunity cost of buying stocks today?
The 4.3 percent expected rate of return is double what investors can earn now on safe U.S. Treasury bonds, and at least 1 percent higher than the yield on investment-grade corporate bonds.
The earnings yield on the stocks of some prominent Idaho companies also show relative value.
Micron Technology is selling at a PE ratio of just 6, giving an earnings yield of more than 16 percent. Boise Cascade’s earnings recently declined, but the earnings yield remains above 6 percent. Idacorp, parent company of Idaho Power, has a higher PE at 17.5, but the company’s regular dividends pay 3 percent alone and the earnings yield is nearly 6 percent.
Based on current prices, these local companies and the overall stock market are expected to produce returns well above those on bank savings or the bond market. Such potential returns are not, however, without risk.
The Federal Reserve is expected to begin raising interest rates this month, and higher rates will reduce the relative attractiveness of stocks. Regardless, higher interest rates have been expected for some time now, and stocks have held their value. In market parlance this means the Fed’s rate hike is already “priced in.”
Even with the risks, stocks remain the best value this shopping season.
Peter Crabb is professor of finance and economics at Northwest Nazarene University in Nampa. firstname.lastname@example.org