New q Valuation for SP 500: Smithers & Co.

History, history! We fools, what do we know or care.-
William Carlos Williams

Doug Short of Financial Life Cycle Planning (www.dshort.com) and I have been exchanging correspondence about the q ratio and its uses. He is generating a methodology to update this measure more frequently. I wrote an article here sharing a few of Smithers thoughts on q as a timing tool. Quite curiously, Smithers & Co., addresses the topic of updates by its readers in its commentary which accompanies the release of its quarterly chart. Let's take a look. Here is the latest chart:



And here is the related commentary:

With the publication of the Flow of Funds data up to 31st March 2010 (on 10th June 2010), we have updated our calculations for q and CAPE, which show very little change from our previous calculations.

Non-financial companies, including both quoted and unquoted, were 62% overvalued according to q at 31st March 2010, when the S&P 500 index was 1169. Adjusting for the subsequent decline to 1087 (10th June, 2010), the overvaluation had fallen to 50%. Revisions to data had little impact on q, with downward revision to net worth for Q4 2009 of 2.9% being offset by a downward revision to the market value of non-financial equities of 2.1%. Net worth for Q1 2010 fell slightly as equity buy-backs exceeded profit retentions.

The listed companies in the S&P 500 index, which include financials, were 58% overvalued at 31st March 2010, according to our calculations for CAPE, based on the data from Professor Robert Shiller’s website. Adjusting for the subsequent decline to 1087 (10th June, 2010), the overvaluation had fallen 46%. (It should be noted that we use geometric rather than arithmetic means in our calculations.)

And what of more frequent revisions? This is what the commentary offered:

As net worth and cyclically adjusted earnings per share change little during a quarter, only changes in share prices are important for changes in the market value between our quarterly updates. The value of the market can thus be readily adjusted by viewers to this website. As the S&P 500 index changes, viewers can simply insert the new value and calculate the q and CAPE values, i.e:

With the S&P 500 at 1169 as at 31st March 2010, q was 1.6166 and CAPE was 1.5761.

To update as at 10th June 2010, when the S&P 500 was 1087, for q take 1.61 × 1087 ÷ 1169 = 1.50 and for CAPE take 1.58 × 1087 ÷ 1169 = 1.46.

Smithers and Wright have written two books on stock market valuation and the q ratio. The first was Valuing Wall Street. The second was Wall Street Revalued. Both are on my bookshelf and are HIGHLY recommended reads for an investor.

The stock market is overvalued. It's as overvalued as it was in 2007 despite never having reached the absolute price level of the SP 500 reached then (1565). That is because earnings are quite a bit lower and the price being paid for them are too high in relation. This overvaluation will resolve itself as it always does. We just don't know when. Long term investors have been warned.