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In This Market, Be Picky and Watch Valuation

U.S. News and World Report Smarter Investor

With new records being set, there are still spots where values might be found.

All good things must come to an end. That is one of the many lessons we have learned over the five years since the collapse of Lehman Brothers, viewed as the tipping point that sent the U.S. into one of the most severe recessions in recent history. So it only makes sense that five years later investors remain tepid about the current bull market, constantly looking over their shoulders to see when the next big downslide will come. With the Standard and Poor’s 500 index up nearly 25 percent year-to-date, it seems only natural that bears, pessimists and talking heads alike would be screaming for a correction.

There are a number of factors currently in place supporting such calls, not the least of which being the sheer notion that the longer we go without a substantial correction (a decline of 10 percent or more preceded by a rally of at least 10 percent), the more likely we are to experience one. The other common claim centers on valuation; are investors paying a premium for corporate earnings that do not support the prices of equities? The 12-month trailing price-to-earnings ratio for the S&P 500 as of October 30th had crept up to 19.46, which means that investors in the S&P 500 are currently paying $19.46 for every dollar of earnings from its constituents over the trailing 12 months. Historically, investors tend to think of 16 as the “magic P/E” number; a stock trading with a P/E greater than 16 is considered dear, whereas a stock trading with a P/E below 16 may be cheap. On average, the S&P 500 P/E tends to fall around a mean of 15.5 and the current reading is well below the highs of over 100 seen in 2009.

That said, we are not necessarily doomed to see a sell off. In fact, we would argue that there are still opportunities to take advantage of the current market conditions. Despite the overall slightly high P/E, many of the companies and industries included in the S&P 500 are trading at fairly attractive prices. The financials and energy sectors, for example, are trading at P/Es below 14. This is where the importance of security selection takes center stage. For every Tesla (forward P/E of 93.28), there is a Ford (9.53); for Amazon (133.94), an Apple (11.16). Not to say that P/E is the only consideration to make when choosing stocks, but it is clear to see by this example just how important security selection is in this type of market.

Most investors are happy to pay a premium, so long as earnings support the price. Luckily, we are in the middle of earnings season. Last quarter, 62.2 percent of companies reported better earnings than estimated. As of October 25th, the current third quarter earnings “beat rate” was 63.5 percent, however more than 1,000 firms had not yet reported, according to Bespoke Investment Group. If the “beat rate” can remain high, we believe this market can support the slightly elevated valuations. With that in mind, our strategy is to only put smart money to work when the price is right and the earnings support future growth.

Kristen E. Owen is a Wealth Management Associate at Monument Wealth Management, a Registered Investment Advisory firm located just outside Washington, D.C. in Alexandria, VA. Follow Kristen and the rest of Monument Wealth Management on Twitter, LinkedIn, YouTube, Facebook, and their “Off the Wall” blog which can be found on their website.

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