A New Record High: Are Stocks Overvalued?

The S&P/TSX Composite Index (TSX:^OSTPX) may have recently hit a new high, but robust economic growth and improved earnings from companies such as Teck Resources Ltd. (TSX:TECK.B)(NYSE:TECK) does not indicate that it is overvalued.

| More on:

You’re reading a free article with opinions that may differ from The Motley Fool’s premium investing services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

Economic downturns as well as market crashes, no matter how uncomfortable they can be, are just risks associated with stock investing. The recent spike in stock valuations, which sees U.S. as well as Canadian equities trading at record highs, has led to a growing cacophony of voices claiming that stocks are now substantially overvalued and destined for a massive correction. While the S&P/TSX Composite Index (TSX:^OSTPX) may have recently cracked the 16,000-point mark for the first time ever, there are signs that stocks may not be as expensive as many pundits believe. 

Now what?

An important gauge for determining whether stocks are overvalued is the price-to-earnings ratio, or P/E, of the S&P/TSX Composite Index. At the time of writing, the index is trading at 15,979.92; after factoring in the collective annualized second-quarter 2017 Canadian corporate earnings, this gives the index a nosebleed P/E ratio of 50.

However, that ratio is lower than what it was in early March 2017, despite the value of the index rising by 3% since then. This can be attributed to stronger corporate earnings for the first half of this year. While that ratio indicates that stocks are expensive because of the significant gap between corporate valuations and earnings, it also suggests that the gap is closing. That gap should narrow further because analysts estimate that between now and the end of 2018, corporate earnings will grow by 9% and then by 5-6% annually thereafter. This will be driven by robust economic growth and higher commodity prices.

This trend becomes apparent when reviewing Teck Resources Ltd.’s (TSX:TECK.B)(NYSE:TECK) third-quarter 2017 earnings. The miner’s quarterly profit popped by almost 8% quarter over quarter and was four times greater than a year earlier. This trend should continue through to 2018 because of firmer copper and zinc prices.

A better means of judging whether the market is overvalued is to look at what is known as the cyclically adjusted price-to-earnings ratio, or CAPE. It was developed by Professor Robert Shiller and works by taking the last 10 years of inflation-adjusted earnings data to produce a normalized P/E ratio. Using this methodology, the S&P/TSX Composite Index has a CAPE of just under 20, which is only marginally higher than the long-term average and also less than where it was in March of this year. Again, that decrease can also be attributed to improved corporate earnings.

Nonetheless, another increasingly popular indicator, because of its use by Warren Buffett, is the market-cap-to-GDP ratio, otherwise known as the “Buffett indicator.” Based on the latest GDP data from Statistics Canada, the S&P/TSX Composite Index has a market-cap-to-GDP ratio of 121%. This is 45% higher than the historical average and 6% greater than where it was in early March 2017, indicating that Canadian stocks are becoming increasingly expensive. 

So what?

There are a range of conflicting signals for investors, but they don’t necessarily indicate that stocks are overvalued or that a market correction is due. This is because GDP and corporate earnings growth is expected to remain robust for at least the foreseeable future, thereby closing the gap between stock valuations and the underlying fundamentals.

Should you invest $1,000 in Solana right now?

Before you buy stock in Solana, consider this:

The Motley Fool Stock Advisor Canada analyst team just identified what they believe are the Top Stocks for 2025 and Beyond for investors to buy now… and Solana wasn’t one of them. The Top Stocks that made the cut could potentially produce monster returns in the coming years.

Consider MercadoLibre, which we first recommended on January 8, 2014 ... if you invested $1,000 in the “eBay of Latin America” at the time of our recommendation, you’d have $21,345.77!*

Stock Advisor Canada provides investors with an easy-to-follow blueprint for success, including guidance on building a portfolio, regular updates from analysts, and two new stock picks each month – one from Canada and one from the U.S. The Stock Advisor Canada service has outperformed the return of S&P/TSX Composite Index by 24 percentage points since 2013*.

See the Top Stocks * Returns as of 4/21/25

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Matt Smith has no position in any stocks mentioned.

Confidently Navigate Market Volatility: Claim Your Free Report!

Feeling uneasy about the ups and downs of the stock market lately? You’re not alone. At The Motley Fool Canada, we get it — and we’re here to help. We’ve crafted an essential guide designed to help you through these uncertain times: "5-Step Checklist: How to Prepare Your Portfolio for Volatility."

Don't miss out on this opportunity for peace of mind. Just click below to learn how to receive your complimentary report today!

Get Our Free Report Today

More on Investing

gas station, convenience store, gas pumps
Stocks for Beginners

2 Automotive Stocks to Buy and Hold for Transportation Transformation

Automotive stocks are looking a bit tough right now, but these two remain strong options.

Read more »

Trans Alaska Pipeline with Autumn Colors
Energy Stocks

How I’d Allocate $1,000 in Energy Stocks in Today’s Market

Discover why energy stocks are crucial for Canadian investors as the election approaches amidst tariff challenges.

Read more »

dividend growth for passive income
Investing

TFSA Investing: Strategies to Maximize Tax-Free Growth and Returns in 2025

This strategy makes sense in the current economic environment.

Read more »

Canada day banner background design of flag
Stocks for Beginners

Where I’d Invest $7,000 in the Best Canadian Stocks Right Now for Long-Term Growth

Wondering how to invest your $7,000 TFSA contribution in 2025? These Canadian stocks could be solid long-term winners.

Read more »

senior man smiles next to a light-filled window
Dividend Stocks

Retirees: 2 TSX Dividend Stocks for Passive Income

These stocks pay solid dividends with high yields.

Read more »

Dividend Stocks

How I’d Allocate $10,000 Across These 3 TSX Stocks for Growth and Income

I'd allocate up to 40% of a $10,000 portfolio to the Toronto-Dominion Bank (TSX:TD) stock.

Read more »

Income and growth financial chart
Dividend Stocks

$3,000 to Invest? 3 High-Yield Canadian Dividend Stars to Buy Now

Here are three top Canadian dividend stocks offering high yields to help you make the most of a $3,000 investment…

Read more »

TFSA (Tax free savings account) acronym on wooden cubes on the background of stacks of coins
Investing

Where to Invest Your $7,000 TFSA Contribution for Long-Term Gains

This quality ETF is perfect for helping a $7,000 TFSA contribution compound.

Read more »