The first quarter of 2006 is over. Now is a good time to reflect on stock prices and the opportunities they present.
Bargains are scarce. Equities are expensive. In recent weeks, Ive heard several fund managers say valuations are still attractive. I dont agree. Generally speaking, valuations are unattractive. Returns on equity are higher than historical levels. A market-wide return on equity of 15% is unsustainable. Price-to-earnings ratios may not fully reflect how expensive stocks are. Price-to-book ratios are more alarming.
There are two additional concerns. Most discussions of the relative attractiveness of equities focus on the S&P 500 and forward earnings. The S&P 500 is not the most representative index. It may not be the best index to consider when looking at market-wide valuations.
Forward earnings are (necessarily) estimates. Where current returns on equity are unsustainable, projected earnings that use similar returns on equity may overstate the earnings power of equities in general. This can occur even where the estimates appear reasonable given current earnings. If you start with unsustainable base earnings, you are likely to...
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