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Lately, a lot of investors (myself included) have been looking at some increasingly frothy-looking stock market valuations and wondering if they may suggest that we are headed for a crash.
There will be a crash sooner or later, of course. There always is. But nobody knows when it will come.
It might start tomorrow – or not for decades. (I would be surprised if we have to wait for decades, but it is a possibility).
While there is a lot of chatter right now about what happens if there is a stock market crash I think another question is worth asking: what happens if the stock market just keeps going from strength to strength?
Reasons to be optimistic
The idea that a crash may be coming is built on several foundations.
One is that many valuations now look stretched by historical standards.
Another is that massive AI valuations look like a bubble. Nvidia (NASDAQ:NVDA), for example, this week hit a landmark $5trn market capitalisation.
It seems like little time since we were marvelling at the first $3trn market capitalisation in history, in 2022. We have since seen a $4trn capitalisation and now $5trn.
But is Nvidia, with its huge valuation, indicative of a stock market bubble? I do not necessarily think so.
The company ‘s revenue in the latest quarter alone was $47bn. Its net income was $27bn.
In other words, this is a massive and massively profitable company. Surging use of AI and the related demand for chips could help the business keep growing fast.
One way of looking at the recent stock market performance is that prices have been trying to adjust to a rapidly evolving business landscape fuelled by the AI boom.
It remains to be seen whether companies like Nvidia can keep up their strong profit growth rates. If they can, the stock market could conceivably keep moving higher from here.
Ignoring the noise
And that’s the rub.
Arguably it is the same with every bull market. Sit out, expecting a crash, and potentially miss out on years of gains along the way. Or throw normal valuation metrics to the wind and invest. Both have a sort of logic, but both can also be poor decisions.
A good starting point to solving that conundrum is to ask: can I really time the market with certainty? The answer, always, is no.
So sitting out waiting for a crash does not necessarily seem like an obvious option, given that I cannot time the market.
Instead, I prefer to do what I do whether the stock market looks cheap or expensive: hunt for individual shares that have an attractive price given their business prospects.
Nvidia’s business does appeal to me. It has proprietary designs and a large, deep-pocketed customer base.
But it faces risks too, such as export limits. Taken altogether, the current price-to-earnings ratio of 57 is higher than I feel comfortable paying. I think valuation always matters, even (or perhaps especially) when other investors are getting caught up in the excitement of a surging market.
Whether there is a crash coming, or the stock market simply keeps hitting new highs, I believe my long-term strategy of trying to find great businesses at attractive prices is a good way to try and build wealth.
