This year's soaring stock market has created some unusual problems for investors. It's not just that rising prices have made stocks more expensive. The valuations of stocks have been narrowing, creating an environment where it's getting more difficult to find stocks that might be undervalued.
According to statistics compiled by Goldman Sachs, the dispersion of price-to-earnings ratios is down to 41 percent, which is the lowest on record. That may sound hopelessly technical, but it actually reveals something significant about the state of the market. At any time, some stocks will be overvalued compared to their earnings, like LinkedIn, with a price-to-earnings ratio of about 1,000. Others will be undervalued compared to their earnings, like the homebuilder Pulte, with a price-to-earnings ratio of just 2.9. Investors use those ratios to choose the types of stocks they want to be.
What the low dispersion number means is that many stocks are trading at roughly the same price-to-earnings ratio. Investors look to those figures to determine which stocks are growth stocks and which are value stocks. But when those figures converge for the market as a whole, it makes stock-picking even harder than it ordinarily is.
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