Why Stocks Are Expensive

As the Dow keeps not quite hitting 20,000, the eternal debate over the market’s priciness is heating up. And while we’d all like to maintain a Warren Buffett-like serenity toward the market’s direction, most business leaders, as a practical matter, cannot. They have to decide whether it’s a good or a bad time for a company to buy back stock, to award employee stock options in large quantities or small, or to adjust their personal investments as retirement approaches. So let’s face the question: Are stocks today cheap or expensive? Articles arguing opposite sides have just been published, one in the Wall Street Journal (stocks are cheap), the other by Fortune’s own Shawn Tully (stocks are expensive). So as not to keep you in suspense, I’m going with Shawn, as I always do in matters of valuation, a policy that has served me extremely well over many years.

The stocks-are-cheap argument proceeds from a few reassuring facts. Corporate profits are rising after having plunged over the past two years. The unexpected election of Donald Trump, which hadn’t been priced into the market until November 9, heralds an era of pro-business and pro-growth policy from Washington. More broadly, the financial crisis scared millions of investors away from stocks; now, as the business environment warms up, many of them will return, and the sheer volume of dollar inflow will push prices higher.

It’s a plausible argument based on observable trends. But Shawn has never favored that type of argument. Instead, he dissects the numbers, and right now they are not comforting. The S&P 500 is trading at a PE multiple of 25.3, which is far above historical averages. That multiple could be perfectly rational, however, if profits are about to explode, and Wall Street analysts are indeed predicting a strong rise. So what’s the problem?

The problem is that analysts tend to fall in love with the companies they analyze and overestimate future profits. If you aggregate their profit forecasts for the individual companies they cover, the result is usually way above the actual performance of the companies collectively – about seven percentage points above, says the FactSet research firm. The coming profit surge is by no means certain. The bulls like to note that certain industries should do much better this year, for example as rising oil prices benefit energy firms. But rising oil prices also impose higher costs and thus lower profits on other companies.

Bottom line, I think Shawn makes the more persuasive argument. Stocks are not cheap. But I also try to remember that even when the market is irrational, it’s perfectly capable of getting more irrational. Alan Greenspan notes that an investor who bailed out of stocks when he gave his famous “irrational exuberance” speech in 1996 would have missed 80% of the bull market’s gains.

I also try to remember that market milestones like Dow 20,000 are meaningless, and just because the index gets close to a round number doesn’t mean it’s about to hit that number. After all, investors got excited about Dow 1,000 when the index hit 969 in December 1965 – but it didn’t close above 1,000 for seven more years. Dow 20,000 could happen this afternoon, or years from now.

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What We're Reading Today

Marissa Mayer to step down from Yahoo's board
She and three other directors will leave the board of what remains of Yahoo after the sale of the company's Internet business to Verizon closes. The company will change its name to Altaba and will be primarily a vehicle to hold stakes in Alibaba and Yahoo Japan. It's unclear if Mayer will step down as CEO as well. Fortune

Google contemplates selling its satellite business
The prospective buyer of Terra Bella is Planet Labs. Sundar Pichai's Google bought the business for $500 million just two-and-a-half years ago, but buying  satellite imagery is cheaper than owning satellites. A sale would further sharpen parent company Alphabet's focus on financially disciplined enterprises, which CFO Ruth Porat has been encouraging. WSJ

Valeant sells skincare brands to L'Oreal
Under CEO Joseph Papa, the troubled pharmaceutical company is raising cash to pay down its $30 billion of debt. Valeant will sell three skincare brands, including CeraVe, to Jean-Paul Agon's L'Oreal for $1.3 billion. It will also unload its Dendreon cancer business to Sanpower Group for $819 million. Reuters

Mars buys animal hospital chain
Grant Reid's company will purchase VCA, which owns animal hospitals across the U.S., for $7.7 billion. While best known for candy bars, Mars also owns a large pet care business, including the Pedigree and Whiskas pet food brands along with pet hospitals. Los Angeles Times

Building Better Leaders

The best employees want a strong culture
And that's an advantage that startups often hold over big employers. But now the giants are catching on, forcing small companies to adapt, says SendGrid CEO Sameer Dholakia. Inc.

A day in the life of an average middle manager
Scott checks his smartphone within 15 minutes of waking up and spends much of his day online and in meetings, except for when he's driving. He checks his phone 149 times. Fortune

A test of a six-hour workday in Sweden...
...found that employees were happier and more productive. But the employer had to hire more people, increasing costs. NYT

Transition Notes

Jeff Sessions confirmation hearing to begin today
In what's expected to be a contentious hearing, Sessions will be among the first Trump cabinet picks to face a Senate committee. The Attorney General nominee, a U.S. senator from Alabama since 1997, failed to receive Senate confirmation for a judgeship in 1986 after comments on racial issues came to light. Minority Leader Chuck Schumer says Democrats will focus on his history on immigration and voting rights. TIME

Ivanka Trump will resign from the Trump Organization...
...in an attempt to clear ethics laws as her husband, Jared Kushner, becomes a senior adviser to Donald Trump. Kushner will step down as CEO of Kushner Companies and as publisher of the New York Observer. The couple will not sell all their assets in those firms, however, instead saying they would make "substantial divestments" of some holdings. Fortune

President Obama says goodbye tonight
In Chicago, Obama will deliver his last formal remarks as president. It's a departure from previous presidents' final addresses, which typically took place in the White House. Officials say he will provide a "hopeful" vision of the future and is not expected to focus on policy. CNN

Up or Out

Rent-a-Center CEO Robert Davis has resigned. He will be replaced temporarily by founder Mark SpeeseWSJ

Goldman Sachs has promoted Elisha Wiesel to CIO. Business Insider

Fortune Reads and Videos

Google wants to bring Pokemon Go-like experiences...
...to museums. It's working with Detroit Institute of Arts to give visitors augmented reality experiences, with additional information overlaying the art on display. Fortune

Guess what -- the Kremlin doesn't like sanctions
A Kremlin spokesman says proposed U.S. legislation to sanction Russia for election hacking would "exclude any kind of dialog" between the two countries. Fortune 

Apple has asked permission...
...to do "high-tech manufacturing" in Mesa, Ariz. The request was filed in June and appears limited to building servers for the company's internal use. Fortune

Spotify has a job opening geared specifically for the outgoing President
It's called "President of Playlists." Obama has assembled playlists for Spotify at least twice before. Fortune

Happy Birthday

Jared Kushner, President-elect Donald Trump's son-in-law and White House senior-adviser-to-be, turns 36 today. Biography

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