When I look at the US stock market today, I see a market priced almost for perfection. According to most measures of market valuation, the US S&P 500 index is trading in the top 1% or 2% of its historical range. In other words, American stocks have been cheaper at least 98% of the time.
Currently, the S&P 500 trades on 25.3 times trailing earnings and offers a dividend yield below 1.2% a year. To me, these are not the fundamentals of an undervalued market — quite the opposite, in fact. Meanwhile, the tech-heavy Nasdaq Composite index is even more expensive, trading on 32.7 times historic earnings and offering a dividend yield of 0.6% a year.
Both indexes hit fresh highs last week, building on previous records this year. While these trends make me nervous, I’m not brave enough to sell my family’s US stocks and walk away. Like my investing hero Warren Buffett repeatedly warns, “Never bet against America”.
My family portfolio made its largest purchases of US stocks in November 2022, just before the US midterm election. Back then, I saw clear value in American shares after steep price falls following the market euphoria of 2020/21. Hence, we invested heavily in mega-cap US companies — and have made life-changing returns since.
Value target
What do I do now, given I see the US stock market as widely overvalued? Despite living in a world of go-go growth stocks, perhaps the answer is to return to my roots as a value and dividend investor?
Checking my family portfolio’s holdings of American companies, one stock stands out for its underperformance. The shares of S&P 500 retailer Target Corp (NYSE: TGT) have crashed hard since their all-time highs of summer 2021.
After collapsing along with global stock markets during the Covid-19 crisis of early 2020, Target stock soared as the US economy boomed again. On 13 August 2021, this stock closed at $261.54, but it’s been steeply downhill ever since.
As I write, this share trades at $86.76, valuing the group at $39.4bn — a fraction of its former peak. Over one year, the Target share price has dived by 44.1%, plus it has plunged by 43.8% over five years (excluding dividends). This has followed a sustained period of slower sales growth, slipping margins, and lower profits.
After such steep declines, this stock looks deep into value territory. It trades on a modest multiple of 10.1 times trailing earnings, delivering an earnings yield of 9.9%. What’s more, the dividend yield has leapt to nearly 5.3% a year — a cash yield rarely seen among S&P 500 stocks.
After crashing by two-thirds since August 2021, will this falling knife keep on falling? In other words, is this stock in permanent decline? I can’t help thinking that there is deep value lurking in this business, despite its problems with weaker sales, profits, and margins.
In summary, I see Target stock as a classic value target — and perhaps one that might attract the attention of a bidder with deep pockets. Also, the shares could rebound if/when Target’s sales start growing again. Hence, I have no intention of parting with our current holding at anywhere near today’s price levels.
