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Its hard to find efficiency in markets when company values seem completely unhinged from reality. Historically, companies were valued with a heavy weight put o

Its hard to find efficiency in markets when company values seem completely unhinged from reality. Historically, companies were valued with a heavy weight put on their financials. That doesn't seem to be the case anymore, and without any clear approximation of how we are valuing companies it feels to me more like pure gambling.

rafaelero 1y ago
Maybe it's your understanding of reality that it's flawed.
- _heimdall 1y ago
  It certainly is, everyone's understanding of reality is flawed. Show your work here though. I'd point to P/E ratios over time [1]. That's a very common signal used when valuing a company and today those ratios are much higher than historic averages, nearing the ratios we saw before the dotcom bubble burst. [1] https://www.currentmarketvaluation.com/models/price-earnings.php https://www.currentmarketvaluation.com/models/price-earnings...
  - yupitsme123 1y ago
    P/E ratios are probably more useful for comparing companies in the same industry at the same moment in time, rather than as a global rule of thumb. Valuing a company needs to take risk free interest rates and future growth into account, so it's difficult to compare across vastly different companies and time periods.
    - fc417fc802 1y ago
      Your response seems to imply that there are broad differences in potential for future growth (among other things) today relative to the dotcom era. Could you elaborate? Alternatively, we could cherry pick a single company. How do you justify tesla's p/e relative to the other car companies? From where I'm standing it doesn't appear to make any sense.
      - yupitsme123 1y ago
        P/E simply isn't a very good ratio other than just for a quick glance. Real analysts look at 5+ years future cash flows (not earnings), risk free interest, risk premium, cost of capital, and other factors. Differences in any of those factors between companies or between time periods will determine why a company is valued the way it is. Interest rates are way higher now than a few years ago, and still lower than they were in the 90s. Some companies have cool business models that give them an edge, eg. Being able to generate lots of free cash, being able to invest cash at high returns, borrowing at lower rates, looking in customers, or making deals that will assure high revenue growth for the future. I dont know much about TSLA but I don't think the market sees them as just a car company any more than Amazon was just a retailer.
        _heimdall 1y ago
        Future cash flows are only predictions, you can't "look" at them. Anyone chasing future cash flows is chasing models of the future and st the whims of whatever the models did, and did not, as relevant factors.
infecto 1y ago
There are certainly cases where I would agree (TSLA) that I would never be able to underwrite the investment with my mindset. I don’t think your statement is correct though. There have always been hype growth companies, appetite for risk has increased but the mental model is not foreign. The market is betting on a major shift in some way that the company is doing a lot better than it currently is. This is a lot of tech but for the rest of the market most companies trade within their expectations based on current financials.
- _heimdall 1y ago
  I put a lot of weight behind P/E ratios. Today those ratios are very high compared to historic trends, and are in the ballpark of what we saw in the sitcom bubble [1]. By no means am I saying that is predictive, maybe the ratio isn't as useful as I think or maybe it is less applicable today for some reason. I do have a hard time finding any stocks today that I can justify the market valuation for, though. [1] https://www.currentmarketvaluation.com/models/price-earnings.php https://www.currentmarketvaluation.com/models/price-earnings...
  - usefulcat 1y ago
    Seems like current high P/E ratios could be related to having just gone through an extended period of very low interest rates. When rates are low, some (many?) investors may decide that the stock market looks better than lending (either directly or indirectly). And then that can be a self-reinforcing cycle as well--more money going into stock markets == stocks perform better == stocks look like an even better investment.
  - Fade_Dance 1y ago
    P/E just isn't that useful an indicator to look at. It is near useless for anything focusing on growth rather than profit generation. It's a figure that misses out on NVDA, Monster Beverage (not all growth stocks are tech!), etc. These are the names that have driven the majority of market returns over the past decades. There are entire sectors like SaaS where PE is pretty useless. That's the first (big) reason why PE is increasingly a weak Value (in a broad sense) signal. Another huge one is that companies who are free cashflow monsters that shunt cash towards some sort of internally compounding flywheel (ex: Amazon with AWS CapEx and warehouse buildouts) screen terribly on PE ratio even though the cash they are throwing out is being plugged into a compounding engine far greater than one can find in the broad market. That's a value in and of itself, and obviously demands a premium and is well understood today. Personally, most of the more fundamental oriented stuff I read seems to focus more on figures like sales to EV when ranking "value" in a peer group, not PE. That said, it can be useful. I grabbed some Abercrombie because it's at a PE of 8 and all of the free cashflow goes to buybacks. Mostly chose to discount growth and focus on near term value, so there's no tricky modeling there, and again the cash is just shunted into buybacks and there is no complicated debt situation either. In an "old school" value proposition like that, PE can work decently. But I'm also in a Canadian gold miner which is a far stronger Value proposition, yet it will screen horribly on PE... Go figure.
weego 1y ago
there is a case that the markets are highly efficient, just the the "information" part of the market hypothesis isn't the information a layman thinks are the market signals, and that only the HFT trading firms have the "correct" signals available to them. That certainly accounts for the seeming dissociation between company performance and market performance on certainly "blue chip" stocks
- _heimdall 1y ago
  I think you're coming in with an assumption that HFTs are generally correct in their valuations, and that they are chasing efficiency or proper valuations rather than short term gains. Maybe those would be roughly analogous in a stable situation, but my read is that the big players in the markets today are chasing short term gains despite the signals. I'd point to the housing crisis as a recent example, the biggest banks and funds were massively over valuing real estate and real estate derivatives because they were blind to the actual risks and saw what appeared to be free money.
  - seanhunter 1y ago
    There are so many misconceptions about what HFTs do and if anything they seem worse here than average. HFTs do not (for the most part) have any kind of “valuation” of stocks based on the fundamentals of companies. To a first approximation most HFT strategies are market making- they buy from people who want to sell at 9 and they sell to people who want to buy at 10 and every time they successfully do that round trip they make a dollar. There’s more to it than that because of course there is. Markets are complicated and there are a lot of market participants trying to do lots of things. So sometimes they make use of their knowledge of market microstructure to try to detect and preempt big market moves (eg index rebalances, big portfolio unwind trades etc). But don’t think HFTs have a perspective or care about the value of TSLA or whatever as a company. They basically want people to trade TSLA a lot so they make the vig every time they do. As some sibling has pointed out, they don’t want toxic/directional flow though, they want balanced flow because that means they keep making a clip whereas directional flow leaves them holding a lot of risk one way or the other because they are on the other side of those trades.
ArtTimeInvestor 1y ago
From this and your other replies it seems that you assume the average p/e ratio of the S&P over the last 75 years is somehow the "correct" one and therefore todays S&P's p/e is "unhinged from reality". What would be an argument that supports this? To me, it seems fairly easy to imagine that the p/e of the S&P could increase forever. Either because the increase of the money supply is constantly accelerating or because our ability to increase productivity is constantly accelerating.
- _heimdall 1y ago
  I'm not trying to claim that there is any "correct" p/e ratio, its just an indicator or signal like anything else. The p/e ratio is an interesting indicator because it more directly ties together the how much money the company actually makes relative to what I'm paying for it. P/E ratios over time can be good indicators of relative value of the company. I'm not exactly inventing economic or investment theory here to point to high p/e ratios as an indicator of overvalued companies.
  - deadbabe 1y ago
    the flaw in P/E ratio is that it is only a snapshot of what is currently happening today. For fast growing companies, it’s useless because they quickly add new revenue streams and profits can change quickly. If you are purely investing off of sane P/E ratios, you might make some safe investments, but you will always be late to the party.
    - _heimdall 1y ago
      There's more risk in investing on growth though. You could be late for the party or you could avoid the funeral.
  - ArtTimeInvestor 1y ago
    high p/e ratios as an indicator of overvalued companies Again, you say that as if there was some kind of agreement on what a "high" p/e ratio is. But what is it? Since you multiple times mentioned "historical averages", I guess you assume that above the historical average means "high". But that is a big statement. How do you back it up? Imagine an investor in 1988 (the middle of the p/e chart you linked to) who took your approach. From their perspective, the historical average p/e of the S&P 500 is about 15. Would they have played the market by selling over 15 and buying under 15, they would have missed almost all of the nice long rally that came in the decades after.

rafaelero 1y ago

Maybe it's your understanding of reality that it's flawed.

_heimdall 1y ago
It certainly is, everyone's understanding of reality is flawed. Show your work here though. I'd point to P/E ratios over time [1]. That's a very common signal used when valuing a company and today those ratios are much higher than historic averages, nearing the ratios we saw before the dotcom bubble burst. [1] https://www.currentmarketvaluation.com/models/price-earnings.php https://www.currentmarketvaluation.com/models/price-earnings...
- yupitsme123 1y ago
  P/E ratios are probably more useful for comparing companies in the same industry at the same moment in time, rather than as a global rule of thumb. Valuing a company needs to take risk free interest rates and future growth into account, so it's difficult to compare across vastly different companies and time periods.
  - fc417fc802 1y ago
    Your response seems to imply that there are broad differences in potential for future growth (among other things) today relative to the dotcom era. Could you elaborate? Alternatively, we could cherry pick a single company. How do you justify tesla's p/e relative to the other car companies? From where I'm standing it doesn't appear to make any sense.
    - yupitsme123 1y ago
      P/E simply isn't a very good ratio other than just for a quick glance. Real analysts look at 5+ years future cash flows (not earnings), risk free interest, risk premium, cost of capital, and other factors. Differences in any of those factors between companies or between time periods will determine why a company is valued the way it is. Interest rates are way higher now than a few years ago, and still lower than they were in the 90s. Some companies have cool business models that give them an edge, eg. Being able to generate lots of free cash, being able to invest cash at high returns, borrowing at lower rates, looking in customers, or making deals that will assure high revenue growth for the future. I dont know much about TSLA but I don't think the market sees them as just a car company any more than Amazon was just a retailer.
      - _heimdall 1y ago
        Future cash flows are only predictions, you can't "look" at them. Anyone chasing future cash flows is chasing models of the future and st the whims of whatever the models did, and did not, as relevant factors.

infecto 1y ago

There are certainly cases where I would agree (TSLA) that I would never be able to underwrite the investment with my mindset. I don’t think your statement is correct though. There have always been hype growth companies, appetite for risk has increased but the mental model is not foreign. The market is betting on a major shift in some way that the company is doing a lot better than it currently is. This is a lot of tech but for the rest of the market most companies trade within their expectations based on current financials.

_heimdall 1y ago
I put a lot of weight behind P/E ratios. Today those ratios are very high compared to historic trends, and are in the ballpark of what we saw in the sitcom bubble [1]. By no means am I saying that is predictive, maybe the ratio isn't as useful as I think or maybe it is less applicable today for some reason. I do have a hard time finding any stocks today that I can justify the market valuation for, though. [1] https://www.currentmarketvaluation.com/models/price-earnings.php https://www.currentmarketvaluation.com/models/price-earnings...
- usefulcat 1y ago
  Seems like current high P/E ratios could be related to having just gone through an extended period of very low interest rates. When rates are low, some (many?) investors may decide that the stock market looks better than lending (either directly or indirectly). And then that can be a self-reinforcing cycle as well--more money going into stock markets == stocks perform better == stocks look like an even better investment.
- Fade_Dance 1y ago
  P/E just isn't that useful an indicator to look at. It is near useless for anything focusing on growth rather than profit generation. It's a figure that misses out on NVDA, Monster Beverage (not all growth stocks are tech!), etc. These are the names that have driven the majority of market returns over the past decades. There are entire sectors like SaaS where PE is pretty useless. That's the first (big) reason why PE is increasingly a weak Value (in a broad sense) signal. Another huge one is that companies who are free cashflow monsters that shunt cash towards some sort of internally compounding flywheel (ex: Amazon with AWS CapEx and warehouse buildouts) screen terribly on PE ratio even though the cash they are throwing out is being plugged into a compounding engine far greater than one can find in the broad market. That's a value in and of itself, and obviously demands a premium and is well understood today. Personally, most of the more fundamental oriented stuff I read seems to focus more on figures like sales to EV when ranking "value" in a peer group, not PE. That said, it can be useful. I grabbed some Abercrombie because it's at a PE of 8 and all of the free cashflow goes to buybacks. Mostly chose to discount growth and focus on near term value, so there's no tricky modeling there, and again the cash is just shunted into buybacks and there is no complicated debt situation either. In an "old school" value proposition like that, PE can work decently. But I'm also in a Canadian gold miner which is a far stronger Value proposition, yet it will screen horribly on PE... Go figure.

weego 1y ago

there is a case that the markets are highly efficient, just the the "information" part of the market hypothesis isn't the information a layman thinks are the market signals, and that only the HFT trading firms have the "correct" signals available to them. That certainly accounts for the seeming dissociation between company performance and market performance on certainly "blue chip" stocks

_heimdall 1y ago
I think you're coming in with an assumption that HFTs are generally correct in their valuations, and that they are chasing efficiency or proper valuations rather than short term gains. Maybe those would be roughly analogous in a stable situation, but my read is that the big players in the markets today are chasing short term gains despite the signals. I'd point to the housing crisis as a recent example, the biggest banks and funds were massively over valuing real estate and real estate derivatives because they were blind to the actual risks and saw what appeared to be free money.
- seanhunter 1y ago
  There are so many misconceptions about what HFTs do and if anything they seem worse here than average. HFTs do not (for the most part) have any kind of “valuation” of stocks based on the fundamentals of companies. To a first approximation most HFT strategies are market making- they buy from people who want to sell at 9 and they sell to people who want to buy at 10 and every time they successfully do that round trip they make a dollar. There’s more to it than that because of course there is. Markets are complicated and there are a lot of market participants trying to do lots of things. So sometimes they make use of their knowledge of market microstructure to try to detect and preempt big market moves (eg index rebalances, big portfolio unwind trades etc). But don’t think HFTs have a perspective or care about the value of TSLA or whatever as a company. They basically want people to trade TSLA a lot so they make the vig every time they do. As some sibling has pointed out, they don’t want toxic/directional flow though, they want balanced flow because that means they keep making a clip whereas directional flow leaves them holding a lot of risk one way or the other because they are on the other side of those trades.

ArtTimeInvestor 1y ago

From this and your other replies it seems that you assume the average p/e ratio of the S&P over the last 75 years is somehow the "correct" one and therefore todays S&P's p/e is "unhinged from reality". What would be an argument that supports this? To me, it seems fairly easy to imagine that the p/e of the S&P could increase forever. Either because the increase of the money supply is constantly accelerating or because our ability to increase productivity is constantly accelerating.

_heimdall 1y ago
I'm not trying to claim that there is any "correct" p/e ratio, its just an indicator or signal like anything else. The p/e ratio is an interesting indicator because it more directly ties together the how much money the company actually makes relative to what I'm paying for it. P/E ratios over time can be good indicators of relative value of the company. I'm not exactly inventing economic or investment theory here to point to high p/e ratios as an indicator of overvalued companies.
- deadbabe 1y ago
  the flaw in P/E ratio is that it is only a snapshot of what is currently happening today. For fast growing companies, it’s useless because they quickly add new revenue streams and profits can change quickly. If you are purely investing off of sane P/E ratios, you might make some safe investments, but you will always be late to the party.
  - _heimdall 1y ago
    There's more risk in investing on growth though. You could be late for the party or you could avoid the funeral.
- ArtTimeInvestor 1y ago
  high p/e ratios as an indicator of overvalued companies Again, you say that as if there was some kind of agreement on what a "high" p/e ratio is. But what is it? Since you multiple times mentioned "historical averages", I guess you assume that above the historical average means "high". But that is a big statement. How do you back it up? Imagine an investor in 1988 (the middle of the p/e chart you linked to) who took your approach. From their perspective, the historical average p/e of the S&P 500 is about 15. Would they have played the market by selling over 15 and buying under 15, they would have missed almost all of the nice long rally that came in the decades after.