Valuing companies has become damn near impossible. America's volatile economic environment, currently fueled by low interest rates and a strengthening dollar, has left investors searching for "yield." Nowhere is this transition more evident than in fixed income markets. As investors sell bond and Treasury holdings for high dividend and growth stocks, valuations have soared to record levels. While popular retail stocks like Netflix (NFLX), Tesla (TSLA), and Amazon (AMZN) have soared to new highs, lesser-known companies like Autodesk (ADSK), Adobe (ADBE), and Regeneron (REGN) have sunk my investor sentiment to new lows: markets are experiencing a pricing problem! Hence, I'm anxiously awaiting a historically inevitable outcome... a 5-10% correction.
For reference, the S&P 500 trades at an average P/E of 18. I refuse to touch stocks with price-to-earnings ratios of more than 40; as for companies that fall into the 30-40x range, they must retain strong balance sheets, hold large cash reserves, sell non-commoditized products, and exhibit unparalleled growth potential. Given these standards, there aren't many "overvalued" companies that I'd consider "cheap," which begs the question: how should individuals allocate their capital? The answer is actually quite simple: do your due diligence and invest in fundamentally strong companies.
Some examples of proven, risk-averse securities include Apple (AAPL), Microsoft (MSFT), Cisco (CSCO), IBM, Wells Fargo (WFC), Goldman Sachs (GS), Blackstone (BX), Visa (V), and Gilead Sciences (GILD). Not only do most of these corporations trade at a discount to the S&P 500, but each is also fairly valued from a statistical standpoint. Moreover, each firm is a leader in its respective industry and has little to no debt.
Perhaps more desirable is the fact that the above companies have market caps that exceed $90 billion (less Blackstone), generate large cash flows, and issue generous dividends. For reference (again), the average dividend yield of S&P 500 companies ranges from 1-2%, whereas the average dividend yield of Dow components sits at approximately 2.85%. As you can see below, the average annual dividend of “technically sound” stocks ranges from 0.6-7.7%, whereas Tesla, Amazon, Netflix, Regeneron, Autodesk, and Adobe do not issue dividends.
Obviously, we all maintain different risk preferences, and only Janet Yellen knows when the Fed will hike rates, but in this uncertain environment I’d rather be safe than sorry. China’s recent stock market downturn eliminated nearly $3.4 trillion in paper wealth, sinking ten billionaires to “millionaire” status. Monday’s 8% decline in the Shanghai Composite Index also destroyed $39.5 billion in American wealth. My point: global markets are highly volatile and will continue to reflect uncertainty. My advice: only invest in companies that have the ability to survive, and recover from, intense market corrections.