VALUE: After Hours (S07 E22): The Case-Shiller PE and Valuation Distortions

During their recent episode, Taylor, Carlisle, and Dave Collum discussed The Case-Shiller PE and Valuation Distortions. Here’s an excerpt from the episode:

Tobias: What makes you think that it’s overvalued? What are you looking at to make that determination?

David: I watch 25 metrics. They all seem to tell the same story, unless it comes from some Wall Street sell side analyst who then makes up stuff. The one I like the best for some reason is the Case-Shiller PE. It goes back to 1880. If you look at the average Case-Shiller PE from 1880 to 1990, which I am willing to call a baseline. Okay, I’m willing to say, 110 years sets a baseline for historical returns. It was around 12 or 13, and it just moved in a channel, goes up in the 20s, goes down in the single digits, but it channeled for about 110 years, 1990s. Curiously, 1994, and I’ve been trying to figure out why it left the channel. All the metrics, all left the channel and really never looked back.

And so, it is now parked at a cozy 38. And so, if you’re sitting there with Case-Shiller PE of 38 when historical fair value, or should we say average value is 12 to 13, it means that your ballpark 200% over historical average valuation. So, people will say, “Now, we’re in a different era.” I’ve said, “Look, here’s the deal. If you want to let the markets be threefold over fair value, then you have to assume that you’re going to get a one-third of the cash flow out of these supposed stocks representing revenue flow. So, you can’t win.” People say, “Well, we’ll inflate our way out,” but you can inflate away valuations.

So, if you think about valuation price to book, price to revenue, price to earnings, price to you name it, it’s always a numerator, the stock market, and it’s always a denominator that ought to track it. Meaning, they both adjust for inflation. So, if you try to inflate your way out, you’ll inflate the numerator and the denominator, and you’ll still be 200% over historical average valuation. And so, inflation doesn’t solve the problem.

Tobias: Jake and I are sympathetic to that view, and I think that it’s backed up by Tobin’s Q and any other number of– [crosstalk]

David: Tobin’s Q is another. That’s exactly right. In fact, that was Mark Spitznagel’s favorite. I had dinner with him one night and he said, “Yeah, Tobin’s Q.”

Tobias: I just think that Case-Shiller is easier to calculate. It makes a more intuitive sense to me.

David: Mm-hmm.

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VALUE: After Hours (S07 E22): The Case-Shiller PE and Valuation Distortions

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