Is the Stock Market overvalued?
We are going to try to answer this age-old question, but before we do, we want to remind you what we think of valuing the markets. Valuation should never be used to judge if the market should be bought or sold. Valuation is a way to measure the potential for future long-term returns, especially when determining if the market is overbought.
The economist John Maynard Keynes said, “markets can remain irrational longer than you can remain solvent.” A hallmark of bull markets is they get overvalued and stay that way for some time. For example, in 1996, Fed Chairman Alan Greenspan said that the equity market was “irrationally exuberant”; 4 years before the 2000 dot-com top.
Speaking of the 2000 dot-com top, below is a quote from Scott McNeely (in italics), the CEO of Sun Microsystems in 2002 after the dotcom bust. Sun Micro was a very well-run company and McNeely was one of the brighter CEOs in his day.
Q: Sun’s stock hit a high of $64 (in 2000). Did you think how tech stocks were priced at that time was too good to be true?
A: Two years ago, we were selling at 10 times revenues when we were at $64. At 10 times revenues, to give you a 10-year payback, I have to pay you 100% of revenues for 10 straight years in dividends, assuming I can get that by my shareholders, it also assumes that I have zero cost of goods sold, and zero expenses, which is really hard with 39,000 employees. It also assumes that we pay no taxes, which is extremely hard, as well as paying no taxes on your dividends, which is illegal. On top of all that it also assumes zero R&D for the next 10 years. If I can avoid all of that and keep the current revenue run rate, then all is good. Now, having done that, would any of you like to buy my stock at $64?
Do you realize how ridiculous those basic assumptions are? You don’t need any transparency. You do not need any footnotes. What were you thinking? I was thinking it was at $64, what do I do? I’m here to stand for the shareholders. Do I stand up and say, “Sell”? I’d get sued if I said that. Do I stand up and say, “Buy”? Then they say you are