In late 2011, early 2012, stocks were as cheap as I had ever seen them. All the weird stuff going on last year made it to so the market didn’t go up as it should have.
So the stock market ended 2011 way below where it should have been. Look at the chart on the right. P/E’s were around 14. They shoulda been 16. Coulda been 18.
The great gains made in the first quarter of 2012 have a negative consequence. Unfortunately its taken away half the upside potential the market had.
Example
For example, say I purchased a stock for you at the beginning of the year. This stock was set to make $2 per share in profits, had a P/E of 14, and was $28 a share ($2 x 14 = $28).
When I bought the stock for you I thought the P/E should be 18, so my fair value on the stock was $2 x 18 = $36. I thought the $28 stock was undervalued by $8.
Let’s now assume after the first quarter the stock is $32, with the profit picture remaining the same. So now the P/E is 16 ($2 x 16 = $32). The stock has gone up $4 a share — unfortunately, the fair value on the stock is $36 — so now the stock is only undervalued by $4.
Sharek’s Take
The stock market used to have a P/E of 14, has P/E of 16 now, and should be on its way to 18 times earnings. Although the gains are great, the market isn’t on sale like it was three-to-six months ago. Stocks just aren’t as cheap as they used to be.
