Is the Stock Market is Overvalued as of Nov, 2021?

After almost 13 years of this bull market despite some phases of corrections in 2015 and 2016, as well as the 2018 and 2019, also the tumble during the coronavirus pandemic, Does the stock market right now considered overvalued?. It is really hard to answer this question since there is no science involved. It is just human behavior that is really hard to predict and some of financial valuations art that can be relied on. Financial valuations depend on the financial statements released by those companies listed in the stock market which shows the financial positions of these companies and the income statements as well as the cash that these companies made during a period of time either quarterly or yearly.

Theoretically, the stock price should always go up because it’s just a reflection of the company that designed and operated to make a profit and add value to the economy. But once the stock price goes down that means there is something that goes wrong in this company in its way of handling its business that made its reflection in the stock market drop-down. But that is theoretical speaking because stocks might go down for so many reasons which include as explained earlier human behaviors which can not be explained. But there is one piece of the puzzle here that can help investors to see if the stock market is overvalued or not, that called in the financial valuations analysis, the intrinsic value of the stocks. This intrinsic value of the stock is what investors are willing to pay pulse the premium to invest in a company. This intrinsic value is driven from the financial statements of the company and can be calculated using many ways one of which is considered the most applicable and accurate one that used the free cash flow generated by this company which then discounted to the present value. This method is called Discounted Cash Flow (DCF) and there are so many resources available on the internet that explained this method and help investors to come up with the intrinsic value of the stock of a company.

By applying (DCF), I came up with the intrinsic values of two main companies which are Microsoft and Apple. The reason that I choose these two companies is that they are both parts of the Dow30 Index and S&P 500, and they are both considered the two giant companies in the market based on the market capitalization.

Company NameMarket capitalizationStock Price Company Stock Fair Value
Microsoft2,528 Trillion336.72 $203.45 $
Apple2,461 T149.99 $105.6 $
Fair Value of Microsoft and Apple

As it appears above the stock price of Microsoft company is 65.5% higher than its fair value, while apple on the other hand is 42%. This shows that there is an inflation in these stocks prices which is more than 53.7% on average.

These intrinsic values have some assumptions which means that there is an error factor that should be applied here which is assumed to be 10%. If this error is applied that means the average inflation above which is 53.7% can be either 43.7% or 63.7%. These intrinsic values are calculated with the assumption that the investor will collect his/her profit in 2023, which means that these values will be changed if the ending year was 2030 or 2040. All this lead to the things said before, which is financial analysis is an art that based on the assumptions that the analyst used to come up with the intrinsic value, but at least this shows somehow that these stocks are not going up because of their intrinsic values have not been reached yet, or if they are undervalued, its the opposite, these intrinsic values show that these stocks are overvalued at this time and its weird they are still going up.

By calculating the intrinsic values of Microsoft and Apple, it becomes clear that these two stocks are overvalued. But what about the other 28 stocks for the 28 companies listed in Dow30 or the 498 stocks listed in S&P 500?. I went through some of these stocks especially those listed in Dow 30 index in this post, which shows that the index is overvalued. But regarding the S&P 500, there are many stocks that are undervalued were not discovered yet because they are not discussed in the news or over the internet and many investors ignore them.

If we assume that the market is overvalued, what should investors do about it?. This is the question that must be asked or at least need to be discussed. There are so many things that investors need to do when the stock market is at its peak and the following are some ideas about how to deal with peaks:

(1) Investors should have cash in their portfolio, by liquidating half of the stocks they own, especially the losers. (2) Never buy overvalued stocks and always buy undervalued stocks especially those stocks in which the difference between their prices and the fair value is 100% or more. (3) Always by stocks their prices are below the Moving average (200) with Return on equity at least 20% or more. (4) Always by stocks their prices are below the Moving Average (200) with Free cash flow double than their net debt.

Randomness of Financial Markets and How can be treated

There is a book called “the random walk down wall street” written by Burton Malkiel. The author tries to discuss in this book if the Stocks market is really moving randomly or there is a pattern in its movement. He explained the four phases of the market which are known as accumulation, trending up, distribution, and finally trending down as the only fact that can be predicted in the stocks market, but all other factors are random. This is in my opinion is not true and I am going to put some thoughts regarding all financial markets stocks, Forex, Futures contracts, and commodities regarding if they are really moving randomly or there is something that is under the investors or traders control can be done.

Stock Market:

The stocks market is the most known financial market that many authors wrote about and try to explain its movement and how can be approached. And it is the most simple market that works in a predictable fashion. The reason behind that is because it consists of stocks of companies which are only a reflection of the financial statements of those companies. what I meant here is that if the fair value of a stock that is generated from the financial statement of its company is high and the price of this stock in the market is low that means definitely you need to buy this stock and wait until it reached its fair value to sell it and make a profit or keep it if the last financial statement for that company released and showed that there is an increase in the fair value of that stock. The only thing that is random here is that when the stock will reach its fair value, is it in a short time period less than 3 months, or is it in a long time period after 1 or 2 or a maximum of 3 years. This is the approach used by the Oracle of Omaha, Warren Buffett, Who said that I never looked at the screen to see the prices of stocks in the market because it’s just a little fluctuation for the stock prices and at the end, the fair value will be reached. Options which are derivatives instruments generated from stocks of the company also have a fair value which can be used as a guide for those who want to trade it or invest in it. That means somehow they are not moving in a random way and can be treated as socks.

Instruments Short Term Movement 3 monthsLong Term Movement (more than 3 years)Percent of randomness
StocksRandom Movement of PricesMoving toward the Fair Value30% to 40%
OptionsRandom Movement of Prices Moving toward the fair value 30% to 40%
Stocks and options Randomness

Forex Market:

Forex market is the most traded market especially after the advanced technology that was adopted by many individuals around the globe. Unfortunately, those who traded in Forex and believe it’s the most profitable market which is right but if traders avoid using leverage or depend on it at least as little as possible. This market is the most random market of all financial markets not because the traders think it is controlled by big banks such as Citi Bank and HSBC and others. The reason is that that many companies that work in multi countries and have different nationalities hedging their profits using this market especially when the cost of their products is in one currency and their profit in another currency. This is known to many traders as institutional trades which is only one of so many ways that institutions trade this market and that is the main reason behind the randomness. Since this market is a decentralized market and since it has so many participants that affect its movement, there is no reliable edge that can be used in this market except trading this market using probabilities trading as the one that i discussed before in this blog as trading probabilities .

Instruments Short Term Movement Long Term MovementRandomness
Forex Pairs Moving in randomMoving in randomAbove 90%
Forex Market Randomness

Future Market:

Future market is also the type of market that is only affected by supply and demand theory. But there is a financial truth which is the main trend for the future market is the downtrend, because farmers who own the physical products such as rice, wheat, and other products are selling contracts in this market as hedging for their real deal on the physical market. One good strategy that can work with people who traded these markets is only to sell this market whenever they see a high in contracts prices. Technical analysis especially the price and volume are the only source of information for the traders who want to have an edge in this market.

Instruments Short term movementLong Term MovementRandomness
Future ContractsRandom movementDown Trend, Selling About 60%
Future Market Randomness

Bottom Line:

To answer the questions that if financial markets is random?, the answer is for the short term they are working in a random way, but in the long run, the only market that is not moving in random is the stocks market and those markets that rely on it, which will always appreciate the fair values of those stocks either if they are undervalued or overvalued

Dow 30 Overview As March 20,2021

In my early posts I wrote about Dow 30 industrial average index and how it seems to me as overvalued compared to fair value of those stocks that included in it. Here I will list all the stocks inside the Dow 30 index and their fair values and the prices they are trading with in market. Based on the fair values of these stocks, a conclusion about if the Dow 30 is overvalued or undervalued or stable and has fair value can be made.

Company NameTicker Price of Stock Fair value of Stock
Apple IncAAPL119.9957.54
AMERICAN EXPRESS COAXP140.7111.9
BOEING COBA255.82-25.5
CATERPILLAR INCCAT225.2915.15
CISCO SYSTEMS INCCSCO48.9840.73
CHEVRON CORPORATIONCVX103.3826.33
WALT DISNEY COMPANYDIS191.1434.35
DOW INCDOW63.91114.74
GOLDMAN SACHS GROUP INCGS344.2-845
HOME DEPOT INCHD289.1313.26
INTERNATIONAL BUS MACH CORPIBM128.9375.03
INTEL CORPINTC63.766146
JOHNSON & JOHNSONJNJ160.04204.6
JPMD JPMORGAN CHASE & COJPM155.14-864
COCA-COLA COKO50.8170.6
MCDONALD’S CORPORATIONMCD222.44265.67
3M COMPANY3M188.71255.53
MERCK & CO INCMRK77.51162.31
MICROSOFT CORP.MSFT230.35141.09
NIKE INCNKE137.4923.17
PFIZER INCPFE35.5367.55
PROCTER & GAMBLE COPG128.01327.14
RAYTHEON TECHNOLOGIES CORPORATIONRTX78.3619.62
TRAVELERS COMPANIES INCTRV149.3725.6
UNITEDHEALTH GROUP INCUNH365.58576.15
VISA INCV206.982.67
VERIZON COMMUNICATIONSVZ56.24413.81
WALGREENS BOOTS ALLIANCE INCWBA52.54450
WALMART INCWMT131.74716.45
EXXON MOBIL CORPORATIONXOM56.490.25
Stocks Prices Compared to their fair values as of March 20, 2021

The above table listed all the 30 companies that are listed in Dow 30 with their prices and their fair values. There is some notes that should be clarified to make the above table reliable.

Notes:

  1. The above table is not a recommendation for any stock in any trade, if you want to buy or short any stock do your due diligence and make sure that your investing or trading systems align with the information listed above.
  2. The assumption used to estimated the fair values of all the stocks above is as if theses companies growths’ are similar to the USA GDP growth which is 2.2%.
  3. Some of the above fair values is in minus (-) which does not make sense, but it can provide a clue about how these stocks are completely overvalued.
  4. Number of overvalued companies are (14) which is have the companies in the Dow 30 index, that might be the reason why the DOW 30 still in uptrend or sideway, and traders should exercise caution if they want to short stocks in uptrend with high momentum.
  5. Traders can use their systems to look for short term deals that presented for them by market movement, investors on the other hand need to stick to stock fair value instead of its price, because even if there will be bear move the market at the end will appreciate the stock fair value and move toward it.

Stock fair value is something completely different than its price which is listed in the market that affected by the law of supply and demand. The wise investors need to distinguished between these two things and never buy stock that its price higher than its fair value and, never sell stock that its price is lower than its fair value.

Dow 30 still overvalued even after Nike Releases its earning report

Even with Nike earning report that released Dec 18,2020, the Dow 30 index still overvalued compared to the Sam 30 index that I released in the previous post.

Dow 30 as Dec 21, 2020 Sam 30 as Dec 7, 2020Same 30 as Dec 21, 2020
30,061.09 22,495.92 22,571.28
Sam 30 compared to Dow 30 AS of Dec 21, 2020

As you can see above Sam 30 as of Dec 21, 2020 has jumped up as a result of increase in Nike stock value with 75.36 points but it still shows that Dow 30 is overvalued since the difference between the two is 7,489.81 points for the Dow 30.

And as discussed in the previous blog when I explain Sam 30 and how it works with Dow 30, when Dow 30 is greater than Sam 30 then it means that Dow 30 is overvalued, and when Dow 30 is less than Sam 30 then Dow 30 is undervalued, and when they are equal then that means the market is has fair value.

Dow 30 index is overvalued as of Dec 7, 2020

The Dow 30 index is a general index that measure the sentiment of the US equity market as well as investor in long run since it consist of the main 30 companies that affect the market and the economy in general. This index shows if the market is going in uptrend, downtrend or sideways. Because of that I used this index as a base for my analysis and I used all companies inside this index in order to come up with my index which shows the real value of Dow 30 index. My index which I am going to call it Sam 30 index is based in Dow 30 index as benchmark to all investors and traders alike to see if the Dow 30 index is an overvalued or undervalued or has fair value.

I am not going to describe the process that I did to come up with Sam 30 index, instead of that I am going to discuses how does Sam 30 index can be used in conjunction with the Dow 30 index in order to allow investors and traders see if there is an opportunity to go long or short or even to step aside and do nothing.

Let us assume that the Dow 30 is 30,000 points and Sam 30 is 23,400 that means the Dow is greater than Sam 30 with more than 6600 points, which means the Dow 30 is overvalued and investors should not invest in the market , and traders on the other hand should apply their technical analysis to see an opportunity for shorting any overvalued stock in this market. The same is true if the Dow 30 was 23,400 points and Sam 30 was about 35,000 that means the market is undervalued and investors and traders should look for an opportunity to go long with any undervalued stocks.

Sam 30 is not day by day index, instead is an index where its value updated whenever new earning report released by the companies that built the Dow 30 index. Once the earning report released for any company of those 30 companies that listed in Dow 30, Sam 30 index will be updated to its new value in the next day.

As of December 7, 2020 the Sam 30 value is 22,495.92, that means, when we do our analysis that described above, the market is overvalued

Dow 30Sam 30
30,218.2622,495.92
Comparison between Dow 30 and Sam 30

As you can see above the Dow 30 is greater than Sam 30 with more than 7,700 points which means that the market is overvalued and I suggested that investors to step back and do nothing while traders can short any overvalued company based in their technical analysis.