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 Name||Market capitalization||Stock Price||Company Stock Fair Value|
|Microsoft||2,528 Trillion||336.72 $||203.45 $|
|Apple||2,461 T||149.99 $||105.6 $|
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.