By: Dividend Sensei
With the stock market now in year nine of its latest rally (the second longest in history), and trading near all time highs, it’s understandable that many investors think that valuations aren’t just too high, but that the market is in an outright bubble. After all, the Cyclically Adjusted Shiller PE or CAPE ratio, which is the inflation adjusted aggregate of the last 10 year’s of S&P 500 earnings, is at a frightening 29.38, the third highest in history. The only other times it was higher was right before the Great Depression, and during the tech bubble of the late 90’s. Both times a CAPE this high has been followed by tremendous crashes, on the order of 50+%.
So why did history’s greatest investor, the legendary Warren Buffet recently tell CNBC that “We are not in bubble territory or anything of the sort.“? It’s because there’s more to “bubble” territory than simply valuation metrics.
For one thing you have to understand that things like the CAPE ratio aren’t fool proof. For example, corporate earnings have changed a lot over time, due to the introduction of things like GAAP, or generally accepted accounting principles, were first created in 1939, and have changed frequently over time. In addition, valuations are affected by numerous outside factors, such as: inflation rates, taxes, interest rates, and demand for investable securities.
Think of it like this. Since 1871 the CAPE has a median value of 16.1, much lower than today. BUT for much of that time period investing was far harder, and riskier than it is today. There was no SEC, meaning that prior to 1932 there was a lot of dodgy corporate practices and outright fraud going on. And before standarization of accounting principles the earnings that companies were reporting had to be taken on faith.
This means that investors had to discount earnings a lot more than they do today, when there are far more investor protections in place. In addition, in decades past, before the rise of the internet, access to quality information, as well as extremely high trading costs (before discount brokers commissions could be $100-$200 or more). This meant that investing in stocks was pretty much the domain of the rich alone.
Then there’s the fact that today things like 401Ks, IRAs, and numerous pension funds mean that the amount of tota capital looking for a good place to earn a return is far greater. Naturally, the result of all these changes, as well as the fact that interest rates (which affect the discount rate investors use to value future earnings, cash flows, and dividends) have been falling for the last 35 years, will mean that the proper or “fair value” of a dollar of corporate earnings is much higher than it was in the past.
In fact, if you had waited for the CAPE ratio to signal that stocks were “cheap”, say by waiting for the ratio to dip beneath 15 before buying, then you would have sold in 1989 and not been in the market at all ever since. In that time, even adjusting for inflation, the market is up 7.5 fold.
Now that doesn’t mean that today’s market isn’t overvalued, because it almost certainly is. But, since market timing has been proven to be the absolute worst thing you can do, that means that investors need to be very careful about where they put new money to work. Luckily, no matter how frothy the market gets, something is always on sale. Specifically, retail REITs have been absolutely hammered in recent weeks, due to ongoing concerns that Amazon (AMZN) is going to lay waste to the sector. Fortuantely, the best names in the industry, including Simon Property Group (SPG), Kimco Realty (KIM), and Tanger Factory Outlet Centers (SKT), are all well situated to not just survive the rise of e-commerce, but continue thriving in the years ahead. Which is why these, and a few other quality dividend growth names in the sector are the best place to invest new money right now. Just how undervalued are they? Well take a look:
Kimco Realty: 27% undervalued
Tanger Factory Outlet Centers: 24%
Simon Property Group: 24%
Macerich (MAC): 23%
And this is just one sector of one industry (REITs). There are plenty of other great dividend growth opportunities, in numerous other areas of the economy that still exist, you just have to know where to find them and how to recognize them. That’s why I’ve devoted my life to helping to not just teach investors about how to invest succesfully for the long-term, but to point out the specific opportunities that can help you achieve your financial dreams at any particular moment.