This Time it Really is Different


Stock market capitalization to GDP was once Warren Buffett’s favorite indicator. A quick glance of this ratio shows it recently blew past the two previous highs. Nobody reading this needs to be reminded of what followed those peaks.


Below is another metric that shows you have to be out of your mind to own U.S. stocks. The median price/revenue ratio for U.S. stocks makes the tech bubble look quaint.


But before you go putting on some hedging trades, maybe investors aren’t out of their minds, perhaps there is a reason why the two previous charts appear so jarring.

Credit Suisse recently published an incredible paper, which examines why companies are staying private for so long, and what effect this might have on the shrinking public markets. Below is a chart which shows, “the cash flow return on investment, a measure of corporate return on investment that is adjusted for inflation, for a large sample of U.S. companies. The average CFROI from 1976 to 1996 was 5.5 percent and rose to 9.1 percent from 1997-2016. Much of this improvement is the result of higher operating profit margins.”


They go on:

“As the result of this profitability, and in spite of the smaller population of companies, the equity market capitalization in the U.S. has risen from 47 percent of GDP in 1976 to 136 percent in 2016. Over the same time, profits went from 6.9 percent to 8.9 percent of GDP.”

“So what,” you might say, do companies with greater margins deserve higher valuations? I don’t know, but I think it’s safe to assume that low margin companies deserve lower valuations. And because so many of these tiny, crappy companies no longer exists, then the median price/revenue ratio chart is a little less shocking.

Look, I’m not saying stocks are cheap. Based on every traditional valuation metric, stocks look really expensive. But I’m just saying, it’s possible that they’re only sort of expensive.


The Incredible Shrinking Universe of Stocks The Causes and Consequences of Fewer U.S. Equities

Further Reading

What if Earnings Never Collapsed?