“There are no bad assets, only bad prices.” Most of us have heard this phrase, and it is a simple but profound idea—the price you pay for any investment is more vital than the inherent ‘good’ or ‘bad’ qualities of that investment. For example—consider a company that is in long-term decline, such as a landline telephone company. The trend is pretty straightforward: every quarter, their customer base will shrink further and further. Bad investment? Not necessarily. It could be a great investment if you can buy it cheaply enough.
History provides us examples of the opposite. During the late 1990s, technology and internet companies saw their stock prices surge as investor enthusiasm reached a fevered pitch. Oracle, a software and database technology company, was unquestionably a high-quality, industry-leading name. It was a ‘good’ company. The problem was that investors lost discipline in what they were willing to pay for Oracle stock, along with many other dot-com era stocks. By the mid-2000 peak, Oracle (and the NASDAQ overall) traded at roughly 140x forward price/earnings multiple, an insanely high number compared to the long-term NASDAQ average of 20-25x and the long-term average for the S&P 500 of 15-18x. Today’s large tech names do not trade anywhere close to 140x, either. NVDA currently trades at 44x. MSFT, GOOG, and AAPL trade anywhere from 20x to 35x. Elevated by historical standards, but not the madness seen in 2000.
As most of us know, the dot-com bubble eventually burst. When it did, Oracle’s stock price fell over 80%. The fact that Oracle’s core business remained resilient was likely cold comfort for investors. An example of good asset + bad price = bad investment.
So, where does this leave investors today? Are we at ‘good’ or ‘bad’ prices in the stock market? There are countless methods, conventions, and rules of thumb that investors deploy to get an idea of this. The most well-known and most cited example is the forward price-to-earnings ratio, or ‘forward P/E’.
Currently, the S&P 500 is valued at a 21-22x forward P/E. As mentioned above, the long-term average for the S&P 500 is 15-18x. Many investors point to this as a reason why the stock market is overvalued. But there are counterarguments. Bullish (or at least not bearish) investors point out that today’s stock market should be valued higher versus the historical average because corporate profit margins are higher than they were in the past. American corporations are just more efficient and better at making money nowadays.
Additionally, the S&P 500 of today is not the same as the S&P 500 of past decades, and the most consequential sector, technology, is unique. It is the largest, it is the fastest growing, and it has the best profit margins of them all. Why wouldn’t investors pay more?
Which argument is correct? Unfortunately, we are going to have to wait and see. Our view skews to the positive side of the debate based on the solid fundamentals of our economy. Gross Domestic Product (GDP) is growing at a healthy +3% clip, unemployment remains close to historic lows, inflation remains in a good place, and corporate profits are expected to grow 15% in 2025. While it is unlikely that equities will have another blockbuster year, it seems plausible the stock market could produce positive (but more modest) gains in 2025