By Mark Hulbert
Can companies’ “intangible assets” rescue the stock market from being extremely overvalued?
I’m referring to a valuation gauge known as the price-to-book ratio. As you might recall from my previous reviews of the eight valuation indicators with the best long-term records , the S&P 500’s /zigman2/quotes/210599714/realtime SPX -1.54% price-to-book ratio currently is higher — and therefore more bearish — than at almost any other time in recent decades.
As you may also know, however, book value — the denominator of the price-to-book ratio — largely excludes intangible assets. Since such assets are playing an increasingly important role in the information economy, reported book value is thus artificially low — and, correspondingly, the price-to-book ratio is artificially high.
By one estimate, from Ocean Tomo , a consulting firm that focuses on intellectual property, intangible assets now account for 90% of the total assets of S&P 500 companies, up from only 17% in 1975. This raises the possibility that the stock market might be fairly valued or even undervalued if intangible assets were incorporated in the calculation.
That’s what I set out to explore for this column. This is the latest in my investigations into whether we can wriggle out from underneath the overwhelmingly bearish message of these eight indicators. Previous columns have explored topics such as whether low interest rates justify higher valuations , if buybacks can explain the market’s low dividend yield , and whether the increasing proportion of corporate sales coming from outside the U.S. can explain why the Buffett Ratio is so high .
Unfortunately, including intangibles doesn’t reduce the price-to-book ratio enough to give the bulls much to hang their hat on. That’s according to data provided in an email from Chris Brightman, CEO and chief investment officer at Research Affiliates, the investment firm founded by Robert Arnott. The firm estimated what the aggregate price-to-book ratio would have been for large- and mid-cap sectors of the U.S. market if intangible assets were included in the calculation of book value. The firm has comparable historical data for each month dating to 1984.
As of the end of November, according to the Research Affiliates estimate, this modified and updated price-to-book ratio was at the 96 percentile of the historical distribution. That’s only slightly better, or lower, than for the unmodified version of the price-to-book ratio — and therefore only slightly less bearish.
Current status of valuation indicators
It’s getting harder and harder to avoid the conclusion that the stock market is overvalued. The table below reports the latest values of the eight indicators that I have found to have the best record predicting the stock market’s 10-year returns. As you can see, it’s not just the price/book ratio that is indicating the stock market to be at or close to an overvalued extreme.
|Latest||Month ago||Beginning of year||Percentile since 2000 (100 most bearish)||Percentile since 1970 (100 most bearish)||Percentile since 1950 (100 most bearish)|
|Buffett ratio (Market cap/GDP )||2.03||2.06||1.82||99%||100%||100%|
|Average household equity allocation||50.9%||50.9%||47.6%||99%||99%||99%|
Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be reached at firstname.lastname@example.org .