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Multiple Inequality

Income inequality has become a hot political topic in recent years. There is a growing gap between the richest and the poorest in our society. While I won’t venture into political views in these posts, I think there is a similar phenomenon going on in the US stock market right now. I’ll call it “multiple inequality.” The US companies that have contributed most to the current 10-year bull market in stocks (Amazon, Facebook, Netflix, etc.) trade at very high prices relative to their earnings (P/E multiples) and their book values (P/BV multiples). This is despite the fact that they are already among the largest companies in the US and will find it very difficult grow in the future at anything close to their historical growth rates. The entire S&P 500, led by these technology companies, is currently trading at a 23x trailing P/E multiple (vs. the long-term average of 15x).

At the other end of the spectrum, there are literally hundreds of publicly traded US companies currently trading below their long-term average in terms of P/E multiples. This is because while their earnings have grown significantly during the current economic expansion, their stock prices have not increased as much. In fact, Dimensional’s US Small Cap Value Fund is a collection of nearly 1,000 publicly traded US companies that can currently be purchased for a 12x average P/E multiple. While I believe there is substantial risk in paying a high multiple on high earnings to buy the largest US tech companies that have led the current bull market run-up, I do not see much risk in acquiring a diversified portfolio of small cap companies at a below-average P/E multiple and holding them for the long term. So while the overall US stock market is generally considered “expensive” or overvalued by many investment managers today, it is really more of a barbell with a smaller number of very large companies trading at very high multiples on one end and a collection of much smaller companies trading at very reasonable multiples at the other end. I prefer to invest in the latter.

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