Is it Smart to Buy at an All-time High?

Over the past year and a half, stock prices have surged to record highs. Between anticipation of interest rate cuts and enthusiasm for AI and related technologies, the stock market has produced some of the best returns investors have seen in decades. Should investors buy at today’s highs, or is it better to wait until the next market correction to seek out deals?

Stocks Are Historically Expensive Right Now

There is no two ways about it, stocks are at elevated levels today following the S&P 500’s rise of over 24% during 2023 and tacking on an 8% in just the last three months.

When a market is up by around a third in just 15 months, it’s nearly impossible to see a time in history when earnings follow in tandem to justify those gains.

The takeaway is clear to investors that risks are elevated and expectations for continued and sustained higher highs need to be tempered. Or in other words, the odds of earnings reports justifying present valuations are low.

High market capitalizations and a sharp run-up in prices aren’t the only reasons to signal that the stock market is possibly overvalued. Buffett’s renowned indicator that measures the total market cap of all US stocks versus the expected quarterly GDP is priced at an almost 2-to-1 level. 

Usually when the two are in line, the market is deemed to be fairly valued so a 2x multiple suggests seriously elevated valuations.

Pricing seems even more out of line when examining the mega-cap tech stocks that drove most of the stock market’s gain over the past year.

NVIDIA, for example, trades at over 35x trailing sales and nearly 40x forward earnings. While these numbers may well be justified for smaller companies with large growth potential, the chip giant already boasts a total market cap of over $2 trillion.

Multiples this high among the largest companies are difficult to justify, even when the growth boost provided by AI investment is taken into consideration.

The Argument for Investing Anyway

Even though stocks appear to be trading at high prices today, there’s still a strong argument to be made for investing.

To begin with, the historical trajectory of the American stock market has been consistently upward. Even from starting points when stocks appeared overpriced, the market has continued to generate consistent, positive returns over the long term.

The historical average return of the S&P 500 index, for example, has been around 10.3% per year since the 1950s.

A real fly in the ointment for market timers historically is just how long bullish trends can last. Many attempt to pick the top of the market, at their peril. History shows that in 2021, for example, excessively high stock prices set the stage for the onset of a bear market. Bears were proven correct.

But fast forward in time just a few years and once again the S&P 500 is closing at new record highs. That means that late-in-the-game investors back in 2021 have recouped losses are now entering a period where they too are in the black, further demonstrating the power of long-term buying and holding.

Moreover, attempting to time the market has historically proven to be a quick path to losses or lackluster returns. Even perfectly timing the market produces only marginally better returns than a simple buy-and-hold strategy.

Since perfect market timing is almost impossible to achieve, investors are generally better off investing immediately, even when prices appear higher than ideal.

How to Invest at Record Highs

Although it’s still a good idea to invest, the high valuation of stocks at the moment presents risks that investors would be unwise to ignore. Fortunately, there are a few time-tested strategies that can help investors navigate periods in which there may be few real values to be found.

Arguably the best approach for investing when stocks are expensive is to buy a broad basket of stocks, such as the S&P 500 index.

Investing in large index funds helps to reduce the risk presented by any one stock, thus preventing overvaluation from being as much of a concern. This broad-based approach was championed by Jack Bogle, known widely as the father of index investing.

For those who aren’t sure what to do, one of the safest and best strategies to limit downside risk is to practice dollar-cost averaging (DCA).

It involves buying a fixed dollar amount at a regular time interval. Perhaps it’s just a few hundred bucks a month to get started, the economics of time and compounding kick in and eventually turn small sums into large ones.

The downside of the strategy is a practician never gets to buy the low but equally they never get to buy the high with all their capital. The upside is they can capture the outsized returns that can be had during bear markets.

Over time, dollar-cost averaging permits investors to generate more consistent returns thanks to the regularity of the purchases at fluctuating price levels.

An underappreciated reality of buying stocks at highs versus dollar cost averaging is the willingness of the investor to ride the volatility swings, particularly when it comes to the emotional turmoil that ensues. 

As high share prices turn into corrections and bearish news headlines hit, it’s ever more challenging to ride the wave of lower prices to the ultimate oasis of positive returns. When committing to a dollar cost averaging program that is consistently employed, particularly in bearish markets, the returns can be astronomical over time and the emotional swings can be largely sidelined because the plan is to buy during the dips too.

When Prices Are High, Then What?

While dollar-cost averaging into an S&P 500 index fund will likely produce the best results for most investors, it’s also worth considering the question of how to buy individual stocks when the market appears generally overpriced. For this, there are few better examples to turn to than Warren Buffett.

Buffett, a champion of value investing, made his early fortune identifying undervalued assets. Though his Berkshire Hathaway holding company is far too large to invest in small companies today, the Oracle of Omaha still believes that investors can find mis-priced small companies relatively easily.

Looking at small companies that escape the view of major Wall Street institutions, Buffett advises, is the best way to invest small sums of money for market-beating returns.

More conservative investors looking at single stocks in high-flying markets may also consider buying shares that pay higher dividends.

Dividend paying companies often show a stronger resilience to downturns than their high growth counterparts and as such provide a degree of protection that is comforting when the dominos fall in the wrong direction for the market as a whole.

Arguably the best approach is one of dollar cost averaging into major market indices such as the S&P 500 with a smattering of dividend stocks or an income-focused ETF to complement the portfolio.

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The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.