Despite the current economic
crisis, the stock market is able to recover in the past months and can continue
to do so. People are saying that the market might be overvalued. Stock market
valuation happens when an asset’s worth is analyzed and here, we will see how
it affects the current share price.
The value of a market or a stock
price depends on the value of its future earnings, discounted to its value
today. It can be measured by dividing the amount of capital spent by its
quantity. Over a certain period of time, the stock market fluctuates due to the
influence of downward and upward movement of gross domestic product (GDP).
According to financial experts, the
stock market is more overvalued today than it was 50 years ago according to its
price-earnings ratio (P/E). This ratio is used to determine if a business is
undervalued or overvalued by knowing its share price relative to its earnings
per share. This means that stocks today are more expensive than they were half
a century ago, if the ratio is now at their maximum.
This analysis by Michael Venuto, a
co-founder and CIO of Toroso Asset Management, was supported by other financial
commentators and pointed out that this is caused by the Federal Reserve’s policy,
which creates a large gap in the S&P 500 and real profit.
In the recent stock market climate,
bigger stocks are more expensive than small and mid-sized corporations and
valuations are a lot of times higher in the bigger stocks. Types of companies
and sector composition, investor preferences, forex trading, recent
performances in the stock market and the rebalancing effect, and increase in
intangible assets could be possible reasons why there are differences in
valuation of various market segments. However, the gap between the losers and
winners in the stock market is stretching to levels that are not noticed in
years.
Some say that an increase in the
market’s volatility could result in an increase in discount and decrease in
stock prices. While this can be the reason behind lower equity prices, the
fiscal and monetary policy that have been recently legislated have been more
helpful. This has accommodated the prevention of bankruptcies, protection of
profits, and better forex trading.
The stock market might drop due to
uncertain events in the future, however, markets move and adapt even when
events happen unexpectedly. Also, a one bad stock market year will not make a
huge impact as long as future years return gets back near what is expected.
Decreasing the discount rate will move market prices upwards and the rate at
which earnings are discounted should be noted.
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