Great charts in a piece by “Millennial Investor” Patrick O’Shaughnessy called The Five Year Market Metamorphosis. O’Shaughnessy says that the market is much more expensive now than it was at the bottom in 2009. He cites the following chart, which divides the universe of stocks with a market capitalization >$200 million into three buckets–Cheap, Expensive and Market Median–on the basis of the “EBITDA yield” (1/enterprise multiple).
O’Shaughnessy’s chart shows that the Median stock is at an all-time low EBITDA yield, meaning it’s at an all-time high valuation. As we’ve seen previously (Worst value opportunity set in 25 years, and A Market of Stocks? Distribution of S&P 500 P/E Multiples Tightest In 25 Years), market-level overvaluation of this magnitude has typically led to highly attenuated returns over the ensuing decade.
Optimists often point to the outperformance of value stocks in the early 2000s, which seemed to buck the trend of the overall market. O’Shaughnessy’s chart shows why value outperformed in 2000, but not in 2007. In 2000, Cheap stocks offered enormous 20+ percent EBITDA yields. The Market Median stock, by contrast, offered only around 10 percent, slightly less expensive than it is now. Expensive stocks, on historically low EBITDA yields (high valuations), offered only a little over 1 percent.
Fast forward to 2007. The EBITDA yield on the Market Median stock was comparable to its yield in 2000 (and its yield now), but Cheap stocks were close to all-time low yields (all-time high valuations). That’s why there was nowhere to hide in 2007. Value stocks didn’t offer any more protection than the market did because there wasn’t much value in the “Value.”
The Market Median stock is now more overvalued than it has ever been (or at least in data going back to 1971). The bad news now is that, while the Cheap stocks aren’t quite as expensive as they were in 2007, they’re close.