With the FTSE 100 back near its all-time high and the Nasdaq once again surpassing 4,000, it seems I can’t go a day without someone asking me if we’re in a bubble.
The short answer is: No, we’re NOT in a bubble.
A couple of industries might be in bubble territory, but the market as a whole doesn’t look like it is in a bubble to me.
It’s true that we’ve enjoyed tremendous gains since the 2009 lows, but we also suffered a tremendous fall before reaching those lows.
Share prices have largely clawed their way back up the mountain, but different sectors of the market have led the way.
I search for investment bargains every day and keep a watch list of more than 450 companies
I don’t try to value the market, but I do search for investment bargains every day and keep a watch list of more than 450 companies that I check a few times a week.
The list has at least 20 companies from each of the market’s 10 main sectors, and it shows numerous earnings, cash flow and other valuation multiples.
So between this list and my regular research for new bargains for Motley Fool Share Advisor, I can keep tabs on how overall valuations are trending.
With the exception of large companies with above-average dividend yields, I’m still finding high-quality investment ideas at reasonable prices in the current market.
There are not as many as in 2009 or even in 2011, mind, but they’re still out there. I’m also seeing pockets of the market where there are little or no signs of value.
Twitter has a price-to-sales ratio of 53
Right now, most of the companies I look at I’d say are reasonably to fully valued.
That said, there are a couple of pockets of the market where valuations are absurd. Social media companies are where I am convinced the most serious argument can be made for shares in a bubble.
In the States, Twitter has a price-to-sales ratio of 53, and LinkedIn, Facebook and Zillow all sport price-to-sales multiples of 15 or higher. Just in case you missed it that’s the P/S ratio and not the P/E ratio.
Right behind the social media shares are the 3D printing companies.
Again in the States, 3D Systems and Stratasys, the two leaders in the sector, have price-to-sales ratios of 14 and 10.
However, some of the secondary and tertiary investment opportunities in this sector are more reasonably priced and should do well as the industry grows.
So while 3D Systems and Stratsys could still be great investments from here, I’m more inclined to consider operators such as Dassault Systemes and the like for now.
I recommended an oil and gas opportunity earlier this week
One potential area of value is the energy, resources and commodity sectors. While most of the market has rallied, these shares generally haven’t performed well in the past year.
In some ways this underperformance is fair. Energy, resources and other commodity companies generally have little control over the price of their product and in some cases only limited control of their costs.
Add in the need to constantly replace the oil, gas and other commodities as they are produced, and you have a business model that’s difficult to execute well and even more difficult to sustain.
However, despite all of these challenges, I’m beginning to find resources companies with high-quality assets that I believe have a good chance of growing their production and reserves.
In fact, I’ve just recommended an oil and gas opportunity this week for members of the Motley Fool Share Advisor service.
True, there is still some risk that commodity prices won’t hold up, but some lowly valuations are taking this risk into account as well.
They’ll probably be rewarding investments if their profits continue to grow in the next few years
Another place to look for value is among high-quality companies that may appear fully valued, but because of their quality and consistency are actually valued quite reasonably.
This approach, however, requires some work and thoughtful analysis of future prospects, because companies with P/E ratios of 20 to 35 are only likely to outperform the market if they continue to grow their earnings at a double-digit pace.
There are opportunities such as this in every sector of the market. Some of the more interesting shares pinpointed by this approach are retailers with consistently positive sales growth and room to expand further.
Ted Baker and Dunelm fit this description, and they’ll probably end up being rewarding investments if their profits continue to grow in the next two to three years as they have in the last few.
Two things you can do right now to put your portfolio in a position to outperform in the future
The first is to feel free to ignore the bubble cat calls. There are portions of the market that are richly valued, but this is almost always true. What changes from year-to-year is what portions of the market are overvalued.
The second is to know your temperament as an investor and stick to the process that has worked for you up until now. This will be easier for investors that focus on deep value or growth at a reasonable price.
If you tend to focus on large, stable dividend-paying companies, I think you’ll have to be more selective and patient, or you’ll want to consider looking for reasonably valued companies with above average-dividend growth potential.
That way you’ll pay a fair price for the entire business and through time will earn a sizeable yield as the dividend grows.
