Is the Dow Overvalued?

Is the Dow Overvalued?

The Dow Jones Industrials have been setting new all-time record highs all year long. As good as that's been for bullish investors, the Dow's rise raises concerns about valuation and how much longer the market can keep going up. Still, experts disagree about how to measure whether the Dow's overvalued.

In the following video, Dan Caplinger, director of investment planning at The Motley Fool, takes a closer look at whether the Dow is overvalued. Dan begins with the observation that when you simply look at trailing earnings over the past year, earnings multiples for the Dow don't look ridiculous. Yet if you use the cyclically adjusted price-to-earnings ratio that economists like Robert Shiller prefer, you get higher multiples for the stock market that make current valuations look a bit more troublesome.

Yet Dan believes that the real question is how you perceive what happened during the financial crisis years of 2008 and 2009. Looking at individual stocks, financials had tough earnings years during the crisis. JPMorgan Chase took a hit from bad loans on its balance sheet. For new Dow component Goldman Sachs , a slowdown in underwriting activity and a tough trading environment hampered its results. American Express suffered from its credit exposure to its cardholder clients. Yet since the crisis, JPMorgan, AmEx, and Goldman have all recovered. Whether you prefer the cyclically adjusted valuation method depends on whether you think the crisis was a regular component of the business cycle or a one-time aberration.

Dan further notes that even outside financials, cyclical stock Caterpillar showed some of the same earnings behavior, forcing investors to answer the same basic questions. In the end, Dan concludes that you have to decide which valuation method makes sense for you but that, in any event, there's not nearly as much margin of safety for value investors now that the Dow is at record highs once more.

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Fool contributor Dan Caplinger has no position in any stocks mentioned. The Motley Fool recommends American Express and Goldman Sachs and owns shares of JPMorgan Chase. Try any of our Foolish newsletter services free for 30 days. We Fools don't 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.

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