Why ‘Overvalued’ Doesn’t Mean Sell

One of the biggest mistakes for self-directed investors is hearing that a market is overbought or a stock is overvalued and thinking that means sell. It doesn’t mean sell.

Fundamental analysis is flawed anyway, because it makes a host of assumptions that generally can’t be made and change every day. It can’t be relied on. But still you get analysts or commentators saying something’s overvalued, and the implication is you need to sell it.

Let me tell you – some of the best bits of the market are when the market or a share price goes exponential before the world wakes up to the fact it’s overvalued.

Before the ’87 crash – sorry, aging myself – the Australian market went up something like 100% in just over a year. That’s what caused the crash. Yes, it was overvalued, and it was overvalued for probably the last 80% of that rally.

You would have seen commentators, newspapers, brokers saying it’s overvalued compared to history. Plenty of people would have been wagging their finger, saying it’s all going to end in tears, telling you to sell – when that would have lost you one of the best moneymaking opportunities in stock market history.

The lesson is this: you need to know when something’s overvalued, but not do anything about it. You want the crowd to lose its head. You want it doing 200 miles an hour with its hair on fire in one direction. That’s when you can exploit it.

All you have to do is spot when it changes.

In the ’87 crash, you could see the selling start. In the Big Tech complex at the moment, the average PE for the Magnificent Six is over 30 times. The long-run average on the S&P 500 is 22 times. Over the last ten years it’s been 25 to 30 times.

So yeah, it’s overvalued. Do you sell it? No. You sell it when everybody decides to do something about it being overvalued.

For now, we’re running with Big Tech. We’re happy that it’s overvalued. We want to exploit everybody losing their heads and pushing prices higher. It’s a great theme. It could run for a long time before the herd wakes up to the fact that it’s overvalued.

From those elevated levels – from high altitude – the air gets thin. That’s when it gets easy to pass out. All you need to recognise is the air is getting thin. You don’t need to bail out of the airplane yet.

We’re just waiting for everybody to agree they need to sell because it’s overvalued. We already know it’s overvalued – but you don’t sell.