I’m buying individual stocks because I believe that the S&P 500 is currently too overvalued to invest in. However, my mind is always questioning this decision. Last night as I was sleeping, it hit me that I could backtest what the return of the S&P 500 market would have been if we went from the March 2000 highs until today, with a twist. We know the price is high today, but what if the S&P 500 was priced at 15 times earnings today? That’s my fear scenario. Investing at today’s high, only to have a fairly priced S&P in twenty years when I want to sell.
The high in March 2000 was $1,552.87
The S&P is currently at $4,670.29 with a PE of 29.4.
If the S&P was trading at 15 times earnings today, its price would be $4,670.29 / 29.4 * 15 = $2,382.8
It has been 22 years since March 2000, so I’ll plug the following formula into Google Sheets =RRI(22, 1552, 4670) which gives me 5.1%. Then I’ll plug in =RRI(22, 1552, 2382) which gives me 1.97%. Of course, you do get dividends over this timeframe, but calculating the true impact is hard, especially with taxes.
To reiterate, if you bought the S&P 500 in March 2000 and the S&P was currently priced at a PE of 15, then your return from March 2000 would only be 1.97%, which is less than inflation.
Neither 5.1% or 1.97% sound like a good return to me. Individual stocks are no doubt risky, but I still think they are the better strategy going forward. However, forward PE’s of the S&P 500 assume great earnings are coming. I also concede that perhaps we get to a reasonable S&P 500 price through sheer growth. But I’m not willing to bet on that yet.