Falling valuations drag stock prices down to earth
Stock valuations are falling fast, giving investors a potential opportunity to snap up stocks that may have been overvalued just a year ago.
Take industrial bellwether Caterpillar Inc. Last year the Illinois-based heavy machinery manufacturer was trading at 27 times earnings - that is, the price investors paid for one share of Caterpillar was 27 times its earnings per share, a valuation known as price-toearnings. The overall price-to-earnings ratio for the S&P 500 reached its highest level in at least two decades by early 2021.
Now, with inflation at a 40-year high and the Federal Reserve ratcheting up interest rates at the fastest pace since Pink Floyd’s “The Wall” was in the charts, investors are having second thoughts about how much to pay for stocks. This week Wall Street was valuing Caterpillar stock at just 17 times earnings, a steep drop also seen by retail giant Target and other shares. The ratio of stock prices relative to a company’s earnings is now hovering close to a 10-year average for the broader S&P 500 index.
“There’s some reasonable values out there,” said Brad McMillan, chief investment officer for Commonwealth Financial Network. “Investors don’t need to be terrified at this point as long as they realize volatility isn’t going away.”
The drop in valuations has come from two fronts throughout the year. Earnings growth has been steadily shrinking for the entire S&P 500 since the beginning of the year. Company valuations have also been hit hard by the Fed’s aggressive policy to raise interest rates in its effort to slow economic growth and tame inflation. (AP)