A Unique Way to Value the Market

Before you go, we thought you'd like these...
Before you go close icon

One of the troubles with market punditry is that people can pick different metrics to make whatever case they're trying to make. Some cite variations of the P/E ratio to say the S&P 500 is overvalued. Others use different versions to say it's undervalued.

Truth is probably found by looking somewhere in the middle. Last week, Charles Schwab chief investment strategist Liz Ann Sonders shared a unique way she likes to value market that does just that. Here's what she had to say (transcript follows):


Sonders: I do like to look at forward P/E and make an assumption that estimates, or at least make a call that estimates are not aggressive on the high side or the low side, so if you have some confidence that the stream of estimates over the next 12 months is not out there, then I think it's valid, given that the market is a leading indicator to look forward and not drive the car purely with the rearview mirror. Even on a trailing-12-month basis, the market is still pretty cheap.

But if you want to take a Shiller-type look where you do look back and you look at long term, the one that I favor most was formulated initially by Steve Leuthold, and it's five-year normalized earnings. So it's closer to the six-year business cycle. It's four and a half years of historic earnings, two quarters of forward earnings, so you get that blend of look back and look forward. What I like what he did was he takes the midpoint between reported earnings, which has everything including the kitchen sink in it, and operating earnings, which takes out all the one-time charges. So taking the midpoint gets you a little bit of both. You get a little bit of both in terms of back and forward; you get a little bit of both in terms of the construction of earnings.

Then I think you need to do an inflation adjustment as well. On that basis, on an inflation-adjusted level, we're at about in-line valuation. So again, you can support your case regardless of where you are on the bullish-to-bear spectrum, depending on which valuation tool you decide to choose.

More from the Motley Fool
The Motley Fool's chief investment officer has selected his No. 1 stock for the next year. Find out which stock it is in the brand-new free report "The Motley Fool's Top Stock for 2013." Just click here to access the report and find out the name of this under-the-radar company.

The article A Unique Way to Value the Market originally appeared on Fool.com.

Fool contributor Morgan Housel has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Copyright © 1995 - 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

Read Full Story

Want more news like this?

Sign up for Finance Report by AOL and get everything from business news to personal finance tips delivered directly to your inbox daily!

Subscribe to our other newsletters

Emails may offer personalized content or ads. Learn more. You may unsubscribe any time.

From Our Partners