“Just because the price of something is going up doesn’t mean it’s a bubble. Even if it’s going up a lot. And even if it’s something you don’t like. After all, there might be a good reason it’s going up so much. A good reason like … record profits.”While Matthew was addressing whether, or not, the artificially inflated markets have once again started to reach “bubble” territory, and there are certainly arguments that suggest it well could be, the importance of his argument really focuses around the notion of record profits.
The mistake that is likely being made by many is the assumption that when profits reach a new “record” it is the beginning of a new trend rather than the end of something that begin some time ago. The issue comes when mainstream analysts begin manipulating data in order to justify current market dynamics. In this instance in order to justify high market prices one must assume that the current “record” levels of profits will continue forward indefinitely. The problem with that assumption is that this has never been the case historically and one that will likely not manifest in the future.
The chart below shows several things of importance relating to the current valuation of the financial markets. The only valid measure of market valuation that is historically consistent is trailing twelve month REPORTED earnings per share. Using other measures such as operating, or pro-forma, earnings to try and justify current market levels is both inconsistent and inaccurate when performing valuation analysis. I have also included price to corporate profits (NIPA) per share for a comparative measure.
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