No. of Recommendations: 44
I suspect it's that he agrees with you that the market was overvalued ten year ago, and five years ago, and now. The valuation of the S&P500 has varied enormously over the last 20 years, and it is now as highly priced as it was in the year 2000 - it has, with a very broad brush stroke, followed a U shape with the overvaluation - with large cap stocks expensive in 2000 and 2022, and cheap in 2010.
I wouldn't compare the price to 12-month earnings, with the margins changing so much from year to year (in April 2009 firms had almost no earnings in aggregate) but comparing
price to book value over time is a good proxy for rate of change of value. Book value isn't usually insightful when looking at individual companies but when viewing the market as a whole, it is very good because it is less sensitive to start and end points than the 10 year average earnings (CAPE) which his more commonly referred to by value investors.
Here is the price to book for the S&P500 the last 10 years:
https://www.multpl.com/s-p-500-price-to-bookThat's for the S&P500 - which is what matters to Buffett as he is looking for enormous firms. However for you and me, we should not necessarily be so worried. If we take the Russell 2000 - the 2000 smaller firms within the largest 3000 firms - then right now the valuations are fairly unchanged between now and 10 years ago. Buying now is not unlike buying in 2014 for this universe of smaller firms:
https://ussnsimg.moomoo.com/feed_image/77777017/aa...If you want to look at earnings of these small caps, you must take into account the margins. The small cap margins are, as it happens, only a little elevated right now, and the present PE ratio of small caps is well below the historical average (~14x now, versus ~17x average 1999-2024, see figure 2 of link below). So the price to sales is pretty much average right now - and that will surprise a lot of people looking at the market today in 2024. In the data below, note the low PE of the S&P600 (small caps, similar to the Russell 2000) in figure 9, and then scroll up to figure 5 to check the margins - the margins are not so highly elevated (compared to the margins for the S&P500 which are greatly elevated, and what is worse, the S&P500 P/E ratio is
also high).
https://yardeni.com/charts/sp-600/If you like index investing, you can access the smaller cap stocks by purchasing IJR. This covers the same universe of small caps in the so-called S&P600, except that the S&P600 ads an extra filter that requires stocks to be profitable in the last quarter and the last year. This filter is effective. If you want to track exactly the S&P600 (including the value filter) then you can access that by purchasing
IJS instead of IJR.
Now, over the last even 20 years IJS and IJR had identical performances, however if you go back further in history beyond 30 years, adding the value filter greatly helped the performance of small cap stocks, so IJS is likely to outperform IJR over the next 20 years. Furthermore, IJS (tracking the S&P600) is almost certain to outperform the S&P500 over the next 20 years because (1) its rate of intrinsic value increase as historically been higher than the S&P500 - for example revenue per share + dividends of the S&P600 rose 10% per year the last 20 years, versus merely 7% for the S&P500, and (2) we are starting from a lower valuation with the S&P600 if starting today, so the already considerable outperformance is amplified a little more also from that.
Buffett recommends the S&P500, however the starting point
really matters even over 20 years (look at the return of the S&P500 from 2000 to 2020 and compare it to the return if starting just 5 years earlier or 5 years later - there is a very large difference).
You can alternatively avoid the expensive mega caps also with an equal weight index such as the RSP (this is really the large caps equal weighted, but that removes exposure to the mega caps which is where the overvaluation is right now).
Some of the mega cap firms are going to be go on to be investments from today, I'm sure, so it is a mixed picture, but being exposed to all of them via the S&P500 is likely to have subpar long-term returns. Almost every year there was a concept of "invincible" companies, only with the zeitgeist changing and each time the previous "invincible" turning out to be largely transient. We even revise our own memories about what we believ
ed in the past to be more consistent with the present, leaving us persistently overconfident.
( I did investigate the effect of
combining small cap value (S&P600) with equal weighting: Given that both equal weighting outperforms, and the S&P600 small cap (but cap weighted) outperforms, then why not get the best of both worlds? Well, in backtesting this idea it turns out that equal weighting the S&P600 offered no improvement long-term to the S&P600 itself. )
So from today, 2024, until 2044 (yes I'll keep Shrewd'm here), check back on this post and compare the total return of RSP (large cap equal weight), IJS (small cap with value filter), and SPY (large caps with emphasis to mega caps). I imagine RSP and IJS will be similar, but they will be both better investments than SPY. I'm optimistic as many are about the moats of the present mega caps, but I also like to sometimes read the finance section of newspapers from the distant past (1920, 1940, 1960, 1980, 2000, etc) for entertainment, noting that there was always a concept of each era being unique and the new invincible firms being more reliable than anything in the past, and going on to restructure and/or dwindle.
- Manlobbi
