When a house sells in your neighborhood, many often look to see what the selling price was. Depending upon the price per square foot, you might be relieved or a bit unnerved, especially if your house is also on the market. In real estate the price per square foot is a standard measure of how expensive (or cheap) a house is relative to those that have recently sold. The higher the price you pay per square foot, the more capital you have to come up with. Conversely, if the price per square foot drops in your neighborhood, it’s great news for the buyer but not for the seller.
In today’s equity markets, the P/E Ratio (a measure of the company’s price relative to their earnings) is at 22 times. As a reference point, the historical P/E on stocks is 15.6. Using the same analogy as you do on buying real estate, stocks are more expensive on per square foot basis than they historically have been. If you have stock exposure in a 401k account or an investment account with your advisor, you’ve seen your assets appreciate over the past 6 years, and you’re now living in the high rent district.
The challenge is this: the more expensive the stocks become, the harder it is to project positive forward returns. If you overpay for something and it declines (and it can decline rapidly), you spend much of your time making that money back rather than earning more on your money.
If someone knocked on your door and offered to pay you 40% more than your house was worth, you probably would consider taking it. Why not consider the same in your investment portfolio? The equity market is full of buyers if you’d like to sell some of those appreciated assets. Stock values can decline rapidly without warning and often without reason. It may be a good time to put some of those assets on the market while prices are still high.