Stock market pricing indicates whether stocks are cheap or expensive in relation to earnings. It is a poor indicator of market timing, but good at predicting long-term investment returns. High valuations warn of low investment returns over the next decade, and low valuations indicate an opportunity for above-average returns over a similar period.
Stock Pricing
ASX stock pricing indicates that stocks are overvalued, but not near the extremes of the US market.
We use z-scores to measure each indicator’s current position relative to its historical data, with results expressed in standard deviations from the mean. We then calculate an average of the five readings and convert that to a percentile. The higher stock market prices are relative to their historical mean, the greater the risk of a sharp drawdown.
Buffett Indicator
The Warren Buffett indicator compares stock market capitalization to GDP, providing a stable, long-term ratio with a long-term mean of 1.03.
ASX 20 Price-to-Sales Ratio
The Price-to-Sales ratio for stocks in the ASX 20 uses a 20% trimmed mean to remove the highest and lowest readings, which tend to distort the average.
ASX 20 Forward Price-Earnings Ratio
The Forward Price-Earnings ratio for stocks in the ASX 20 uses a 20% trimmed mean to eliminate the highest and lowest readings. This avoids distortions of the average by outliers.
All Ordinaries Price-Earnings Ratio
The All Ordinaries price-to-earnings (PE) ratio eased to 21.03 in June, down from 21.44 in May. If we ignore the 2020 distortion caused by low earnings, PEs above 20 indicate high pricing. The PE ratio is based on the latest trailing earnings (red below), but produces extreme readings if earnings per share (EPS) rises or falls sharply, as in 2008 or 2020, which is why we also calculate a PE based on the highest trailing earnings.
All Ordinaries PE of Highest Trailing Earnings
We use a Price-Earnings ratio based on the highest trailing earnings for the All Ordinaries Index to eliminate extreme readings when earnings fall sharply. Values above 16.0 indicate that stocks are overpriced, while values below 12 indicate low prices.
However, the ASX has volatile earnings due to the large resources sector. The commodity cycle boom-bust effect necessitates the use of both price-earnings ratios — based on trailing earnings and highest trailing earnings — to provide a more balanced view.
All Ordinaries Dividend Yield
The All Ordinaries dividend yield is below its long-term mean of 4.1%, indicating values are on the high side. A fall below the 3.0% threshold would signal that stocks are severely overpriced.
Note: Lower yields indicate higher values, so we reverse the z-score for the ASX dividend yield.
Conclusion
Stock pricing remains high, with risk of a sizable drawdown.
Related Links
Acknowledgments
- Morningstar: ASX 20 Statistics
- Market Index: ASX Statistics
- ABS: National Accounts
- ASX: Historical Market Statistics