If you ignore the daily warnings that the bull market in U.S. stocks is going to end, and instead look at valuations, you can see something remarkable happening: Stock prices have risen considerably, but price-to-earning valuations have fallen.
A year ago it was not uncommon for self-styled market gurus to say that large-cap U.S. stocks were trading at their highest levels to earnings since early 2004 and that stocks were therefore headed for an earth-shattering decline. But over the past year (through Aug. 31), the S&P 500 SPX, -0.17% has returned 20%, while its forward price-to-earnings ratio (based on consensus estimates for the following 12 months) has declined to 16.9 from 17.6.
If we look at year-to-date figures, the S&P 500’s forward P/E ratio has dropped from 18.3 on Dec. 31 to the current 16.9 as the index has returned 10%.
That’s called having your cake and eating it too, as U.S. economic growth accelerates and companies enjoy greater profitability (and often rising sales) in great part because of the cuts to federal income taxes signed into law by President Trump in December. Ed Yardeni listed other factors supporting rising stock prices.
Among the S&P 500, 312 companies are trading at lower forward P/E valuations than they were a year ago, according to FactSet.
• Narrowing that list of 312 companies, 74 have returned 20% or more over the past 12 months (with dividends reinvested), matching or beating the performance of the S&P 500.
• Among those 74, 48 companies have increased quarterly sales by at least 10% from a year earlier, according to their most recent earnings announcements through Aug. 31.
Among our remaining 48 companies, 34 have posted improved quarterly gross profit margins from a year earlier. A company’s gross margin is sales less the cost of goods or services sold, divided by sales. It indicates whether a company has been forced to lower its prices to defend or improve its market share. A widening margin as sales increase is a healthy sign. (This approach excludes most financial-sector companies, which we will list separately.)
Financial companies
Gross margin figures are not available for many companies in the financial-services sector. Banks and insurance companies use different ratios to measure the profitability of different aspects of their businesses.
