1:16

Hello and welcome back to the Canadian Money Roadmap

1:18

Podcast . I'm your host

1:20

, evan Newvill . On

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this week's episode we're looking at part two

1:26

of investing at all time highs . But this week

1:28

we're taking things a little bit further and looking

1:30

at valuations as opposed

1:32

to just the price level of the stock market

1:35

. Welcome

1:40

back to the podcast . If you have not listened to last

1:43

week's episode on investing at all

1:45

time highs , I'd recommend that you start there and

1:47

go back and listen to that quick episode before

1:50

looking at this one , because last week we

1:52

looked at how returns have been positive on

1:54

average for investors who invested at all time

1:56

highs on a one , three and five

1:59

year basis . But this only looked at the index

2:01

and the price level , not

2:03

necessarily the valuation of

2:05

any stocks within the index . So

2:07

this week I'm going to talk about valuation

2:09

and how that can affect future returns . Now

2:12

I do want to say that there is plenty

2:14

of debate on these topics , and

2:16

so what I'm going to present here is just

2:18

a summary of the empirical

2:21

evidence that I've taken a look at and what

2:24

my conviction is and what my belief

2:26

is . There's a lot of opinion when

2:28

it comes to valuation and whatnot

2:30

, so I like to base

2:32

my feelings on this topic

2:35

, on evidence and

2:37

a whole lot of history , as opposed

2:39

to recency bias or get

2:42

feelings or anything like that

2:44

. So , anyways , that's just my little caveat

2:46

getting into valuations here , because

2:49

this topic is a little bit less black and white

2:51

. So anyways , let's get started here . Number

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one let's just talk about what do I mean by valuation

2:55

Is just whether something

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is deemed to be expensive or cheap

3:00

, or a high relative price versus

3:02

a low relative price . And that relative

3:05

part is critical because what

3:07

makes a stock expensive ? It

3:09

isn't the simple price

3:12

of a share . So if stock A has

3:14

a $200 price per

3:16

share and stock B has

3:19

$50 , that doesn't mean the $200

3:21

one is more expensive , because

3:23

the price does not tell you how many

3:25

shares are outstanding . It doesn't tell you anything

3:27

about the growth of the business . It doesn't tell you anything

3:29

about the profit . It doesn't tell you anything about the assets

3:32

of the company , nothing like that . So

3:34

the price by and large

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doesn't really actually tell you anything

3:39

. It's always the price of a share relative

3:41

to something else . So this is why

3:43

I often use the language of relative

3:46

price . So this is relative

3:48

to something like cash flow or book

3:50

value or earnings , or even dividend

3:52

yield . Dividend yield is relative to the stock

3:54

price at any given time . So

3:56

when a stock has a

3:58

very high price to

4:01

book value , or we call that a PB

4:03

ratio , that means it is more expensive

4:06

than a stock that has a

4:08

low PB ratio . Pe

4:11

ratio is priced to earnings Same

4:13

thing . You can take a look at all of these things and

4:15

compare them to something else . So what a lot

4:17

of people do is they group everything together

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, just like the index , and they figure out what

4:22

the average valuation

4:24

is of the entire group and compare

4:26

that to other times in history . However

4:28

, history is less useful as a guide because everything

4:30

changes . A lot of people have looked

4:33

at the current market and seen

4:35

a lot of big tech companies and

4:37

compared it to back in 2000 when

4:39

there was a big stock market crash because of all the

4:42

tech companies that went bust at that time

4:44

. The difference is a large

4:46

number of those tech companies back

4:48

in 2000 were essentially

4:50

ideas . They weren't real businesses

4:53

that were making any money . Now , some

4:55

of the biggest companies that are at the top

4:57

of the stock market and driving

4:59

the returns of the market for the last decade or so there's

5:01

one of the most profitable companies we've ever seen in the

5:03

history of the planet . The things change

5:06

and valuations change based on

5:08

expected cash flows in the future and all

5:10

sorts of different things . Because , again , a

5:12

price of a stock is based on a

5:14

few fundamental things and a bit of hopes and dreams

5:17

about the future . Every participant

5:19

in the market is buying and selling based on what

5:21

they think it is and today's price is

5:23

the culmination of everyone that's

5:25

feeling really good about the stock and really

5:28

negative about the stock . So

5:30

valuation from my

5:32

perspective is less of a situation

5:34

of , well , this stock is overpriced , or

5:36

this stock is underpriced , or

5:38

the market is overpriced

5:40

and the market is underpriced . So

5:42

from my perspective the price is

5:45

more often than not correct

5:47

based on the millions of participants in

5:49

the market buying and selling based on what they know about

5:51

the stock and what they think about the future . So

5:53

the thing that largely moves stock markets then

5:55

, as a result , because information

5:58

is public for publicly traded stocks

6:00

or surprises . So I'm kind of

6:02

going off script here a little bit , but

6:04

the original point here was that history is

6:07

less of a useful guide because of everything

6:09

that changes over time . So

6:11

history , you know , stock market

6:13

is worth X versus

6:15

30 years ago it was worth Y . You

6:18

know that's more likely to use just as an interesting

6:21

data point than anything that's really instructive . So

6:23

what should we actually do ? Instead for looking

6:25

at valuations , I would recommend looking within

6:27

the stock market and comparing between securities

6:29

to find the groups that might be expensive

6:32

or have high relative prices versus

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the groups that might be inexpensive

6:37

or have low relative price . This is how

6:39

we get to the high level classification of value

6:41

and growth stocks . Value

6:44

essentially means that you're getting a good deal relative

6:46

to other stocks based on the metric that you choose , so

6:48

something like price to earnings ratio or

6:50

price to book ratio . These are the lower

6:53

priced stocks relative

6:55

to those metrics . Growth stocks

6:57

would be the more expensive stocks in those metrics , so

7:00

you'd be paying today for the growth that you hope to get

7:02

tomorrow . This is where it is much

7:04

easier to get more hype and speculation . The

7:07

prices of these stocks are more reflective of

7:09

the idea of what is to come , so there can

7:11

be much more room for error and bigger

7:13

moves when there are surprises on earnings

7:15

or sales or anything like that . Big

7:17

moves can happen in both directions because

7:19

growth stocks are usually priced for

7:21

the best case scenario . Those value

7:24

stocks are priced for low expectations . Right

7:27

, if you have low expectations and they beat them , guess

7:29

what ? You're going to have a

7:31

really nice , pleasant surprise . But if

7:33

you have a growth stock that has

7:35

really really high expectations and

7:37

they meet those really really high expectations , stock prices

7:39

isn't going to really move a whole lot . We saw that recently

7:41

with Nvidia . I talked about that on the podcast

7:44

, just as an example . It was a crazy

7:46

high valuation and they had crazy high

7:48

earnings and the stock went down

7:51

because because that

7:53

price or that that expectation was already

7:55

baked into the price already today . So

7:57

this is again back to that idea of the price

8:00

is often right , quote , unquote

8:02

right based on the

8:04

collective assumption of the future . So

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why ? Why do we bother looking

8:09

at valuation here at all ? Well , this

8:11

matters because value stocks have

8:13

historically outperformed growth stocks . There

8:15

are periods of time where that definitely is not the case , and

8:18

the last few years . Well , going

8:20

back to that decade between

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2010 and 2020 ish

8:24

, that was not the case . But

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if we go back all the way again

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this is looking at the US market , but going back to 1927

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, the average outperformance for value

8:34

stocks in all of those years is

8:36

4.4 percent . It

8:40

is not every year , it is not every decade

8:42

, by no means . But for long-term

8:44

investors the value premium has

8:46

been reliable over a long enough

8:49

period of time . The challenge is you have to

8:51

stay in your seat to get it , and the

8:53

appeal of getting in

8:55

and out and jumping between value and growth

8:57

can be quite high . So , anyways

8:59

, our stock's actually expensive today . This

9:02

is kind of the million dollar question . So

9:04

, as a result of the idea of relative price

9:06

, there's always stocks that are less

9:08

expensive than others . Like I said

9:10

, there's always going to be value stocks

9:13

and always going to be growth stocks , because

9:15

if we look at valuation between securities

9:18

as opposed to the market as a whole , there's

9:20

always opportunity to invest in

9:22

value stocks . So I like to take

9:25

a look at how expensive growth stocks are relative

9:27

to value stocks , just for that

9:29

general data point . Because within

9:32

the market as a whole , the very

9:34

expensive or high relative

9:36

price stocks kind of drag

9:38

up the average compared to everything else . So

9:41

if we're just going to look at the gap between

9:43

growth stocks and value stocks

9:45

today or at the end of last year

9:47

, the most expensive stocks are pretty

9:49

much the most expensive they've been relative

9:52

to any time in the last 30 years and

9:54

that takes a look at a metric called

9:56

the PE ratio , so that's the price to

9:58

earnings ratio . This is data coming from

10:00

JP Morgan Guide to the Markets , and

10:02

this happens from time to time . The

10:05

current forward PE so forward

10:07

means that it takes a look at the anticipated

10:10

earnings for companies going into the

10:12

future . Again , no one knows the future , but there's

10:14

all sorts of forecasts that all these companies do , and analysts

10:16

and whatever , and so the aggregate assumption

10:19

of what the earnings are going to be over the next

10:21

12 months versus the price says

10:23

that for growth stocks , the current forward

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PE is about 26 and a half times

10:28

earnings , whereas for the value segment

10:30

of the market it's only 14.9

10:32

. Let's call it 15 for

10:34

easy numbers , so that gap is pretty

10:37

big . There are many other metrics that you could

10:39

take a look at too to compare , but broadly

10:41

speaking , if you look at the market on average

10:43

, the really expensive stocks

10:45

are really expensive , and

10:47

so if you're looking into that idea of

10:50

value stocks outperforming growth

10:52

stocks , you might say well , I'm just going

10:54

to get out of the market and I'm just going to have cash

10:56

. Unfortunately , this is really tough

10:58

to do as well . There's plenty of studies on

11:00

this . I'm not going to get too into the academic side

11:02

of things , but being able to time

11:05

. We call it the equity premium . So

11:07

that's the idea of owning stocks versus

11:09

bonds or versus cash . Being able to time

11:11

the equity premium based on valuation

11:14

has been incredibly difficult and

11:16

the odds of success there are

11:18

really poor , and timing the

11:20

valuation premium is also

11:22

really difficult . So both of these

11:25

factors the equity premium and the

11:27

value premium are best

11:29

achieved by staying in your

11:31

seat and owning it all the time , based

11:33

on your risk profile and timeline and all these other things

11:35

that I always talk about . So , unfortunately

11:38

, this is kind of a good news . Bad news thing

11:41

is that valuation matters

11:43

, but timing your ins and outs

11:45

of the market based on valuation

11:47

is almost impossible . So

11:49

what do we do about it ? So

11:51

, number one , if you're a passive index investor , so

11:53

someone that owns the entire market using

11:56

index funds , you never do anything about

11:58

it and you just keep buying . This is the buy , an old

12:00

strategy that increases your

12:02

odds of success over time . Stock picking

12:04

is too difficult to be profitable and

12:06

factor timing is impossible to do well . So , even

12:08

if it seems like everything is pointing towards a certain

12:11

outcome . There's a quote that's been attributed

12:13

to many people . I'm not going to try to attribute it to

12:15

any one person , but it's the idea that the market

12:17

can remain irrational longer

12:19

than you can remain solvent . So

12:21

you trying to get in

12:24

and out of the market based on what you think the valuation

12:26

is reasonable or not isn't really

12:28

instructive , because it can stay

12:31

that way for a heck of a lot longer

12:33

than you think and you might just

12:35

lose your shirt in the process . So if you're

12:37

not a passive index investor , there's another strategy

12:40

. Many of my clients would be invested in this way . It's a

12:42

bit more of a systematic way that

12:44

doesn't look at just a pure market

12:46

cap weighted index fund . There are ways

12:49

to invest that actually lean into that

12:51

value side of the market all the time

12:53

. It's kind of always on value

12:55

style of investing . Note that I didn't

12:57

say you go entirely over the value all

12:59

the time , because the risk of getting the timing

13:02

of factors wrong is too high in my opinion . So

13:04

the way that I do factor investing looks at the entire

13:06

market and then tilts towards the

13:08

parts that would have higher expected returns

13:11

, including value stocks . So every

13:13

day you can be positioned with a larger weighting

13:15

in the stocks that have higher expected returns

13:17

, instead of worrying about the valuation

13:20

of stocks in general . That way , if

13:22

the expensive stocks keep getting more expensive , you'll

13:25

be in the game . But if

13:27

the evidence on long term

13:29

investing still holds true where

13:31

value stocks outperform growth stocks over time

13:33

then you're positioned in a good spot as well . This

13:36

can be much more tricky to do for DIY investors

13:38

, and so I recommend that , for

13:40

people that are interested in this style of investing , you

13:43

work with a professional that understands this

13:45

approach . But the main takeaway

13:48

here is that , even if the

13:50

valuations appear to be at

13:52

an all time high , the evidence

13:54

says that that is not instructive

13:56

on any sort of market timing

13:58

strategy that you could employ reliably

14:01

. I'm going to steal a line from one of the research

14:03

pieces from Dimensional where they would say

14:05

market valuations are

14:08

analogous to sundials . They're

14:10

fine as a rough gauge for the passage

14:12

of time , but using one as an

14:14

oven timer may leave you with an inedible casserole

14:17

. I think that's a pretty good analogy

14:20

there . By staying invested

14:22

with a larger part of your portfolio in a

14:24

value tilt , it increases

14:27

your odds of success over a long

14:29

enough period of time . It is not

14:31

any sort of strategy

14:33

for making money tomorrow , the

14:35

next day , over the next

14:37

year ? It might be , but there's no

14:39

short term predictability that

14:42

can be reliably extracted

14:44

from market valuations over the short term . So

14:47

the main conclusions again . Maybe this is

14:49

disappointing to hear , but staying in your seat with

14:52

an approach that matches

14:54

your timeline and your risk tolerance is

14:56

the most reliable way to make money in the

14:58

stock market , even when valuations

15:01

are at all time highs , let alone the prices at

15:03

all time highs . So if you have questions

15:05

about this , I've got a lot of data , a few

15:08

little pieces of research that

15:10

I can extract for you . If anyone is interested

15:12

, shoot me an email at podcast at

15:14

evannewfieldcom , and I'd be glad

15:16

to share some of those with you

15:18

if you're interested . At all , podcasts

15:21

aren't a great medium for sharing a lot of

15:23

academic data , in my

15:25

experience anyways , but hopefully

15:27

this was interesting for you or something helped

15:29

you understand investing

15:31

from a valuation perspective . A lot

15:34

of people ask these questions . I see it online

15:36

all the time . I get emails from clients all the time , and

15:38

so , putting some thoughts together on these two ideas

15:41

of investing at all time highs from a price level

15:43

, but also investing at all time highs

15:45

from a valuation level . I thought was time well

15:47

spent , so hopefully it was for you

15:49

listening as well . I appreciate you listening so

15:51

much . Thank you for subscribing

15:53

and sharing with your friends . I look forward to

15:55

sharing another episode with you

15:57

next week . Thank

16:21

you again for being here . And registered investment fund advisor . Mutual

16:24

funds and ETFs are provided by Sterling

16:26

Mutuals Inc .