 Good day fellow investors! Two days ago I discussed how valuations are perhaps the biggest risk to stocks. And today, when the stock market is continuing on its full, I want to dig deeper into valuations to see what are and how big are those risks, what can really happen. And I'm going to do that by discussing the Dow Jones average index, its price-to-earnings PE ratio, which elaborates current earnings, the CAPE, the Cyclically Adjusted Price-to-Earnings ratio, which is the same thing, but takes into account 10 years of earnings, so the average 10 year earnings. And then I'm going to conclude by explaining to you how earnings grow in the growth of the economic cycle, but the same time valuations expand simultaneously with earnings. So it will be very interesting, let's start by looking at the Dow Jones and the price-to-earnings ratio. Dow Jones has the 40 greatest American companies. It is called Dow Jones Industrial Average, but there is not so much industry anymore. Nevertheless, you have their great companies with great amazing businesses, and we cannot argue with that. Free Am, Caterpillar, Cisco, Coca-Cola, Disney, Home Depot, Goldman Sachs, General Electric, J&J, JPM, Microsoft, Nike, amazing companies. Nevertheless, if you look at the price-to-earnings ratio, the fourth column here, you can see that it is pretty, pretty high. As we have spoken in the other video, the price-to-earnings ratio, the earnings are what determines your long-term return. The average is pretty high here, 45.9 for the Dow, because there are some companies like Caterpillar and Coca-Cola, which have currently extremely high ratios, but that skews the metric. If I take the median, so not the average, which sums up everything and then divides by the number, but the PE ratio of the stock in the middle, the median is 25, just as equal as the SAP 500. The dividend yield is a little bit higher than the SAP 500, 2.4% in respect to 1.8%. So the median price-to-earnings ratio is 25, the earnings yield is 4%, then the earnings yield is then divided into reinvestments, dividends 2.4%, so the payout ratio of the Dow Jones index is above 50%, 60%, and also they are doing a lot of buybacks. So there is little that will push the growth, however, those are great businesses, those will grow as the global economy grows. However, with the PI price-to-earnings ratio above 20 on average, between 25, 20, and 40 on average that's relatively high, that's a return on invest between 3% and 5% among those stocks. There are some cyclic costs, there are some oil stocks where things are skewed. Nevertheless, what I want to dig deeper is to look at the 10-year earnings, because that can tell you, okay, where are we in the cycle and how are the stocks valued and priced in relation to cycles, because as we know, even if the market doesn't speak of it, even if nobody thinks about it, but I have made a few videos and will make more videos about the economic debt cycle, which is normal. And if we look at the long-term earnings, we can see that they are peaking now, but they have been lower in the past, and that is shown by a higher cyclically adjusted price-to-earnings ratio. By adding the cyclically adjusted price-to-earnings ratio, we can see that the average is lower, 29, because the cyclically adjusted price-to-earnings ratio is not skewed by one-off events, like it is the case with Caterpillar Coca-Cola, which will have much lower price-to-earnings ratio next year, that's expected. So this shows you what has been going on during the last 10 years and how much money has the company really made over that time. Some companies have very high capes, Visa 75, UnitedHealth 40, Nike 46, which means that there are more growth companies, Home Depot 53 and Boeing 55. So you have to see, okay, what is going to happen to those stocks? Is the past going to replicate itself, which means that earnings will be lower in the future, or will they continue to grow at current earnings? So that's the question you have to ask yourself before investing in those stocks. And then you have to see if you're happy with the earnings yield that they offer now. Nevertheless, the CAPE ratio says 29, which means that the cyclical return on investment should be around 3.3%, which is even lower than the price-to-earnings ratio. As I said, we are in the late part of the economic cycle. Everybody is employed almost. Everybody has money. Everybody is very focused on consumption, very, very convinced about it. The consumption rates are very, very positive globally. This means that the maximum that those companies will reach in relation to their earnings is now. So when the recession, next recession comes, those earnings are going to fall. And then what happens is that usually valuations contract too. And that is something that takes by surprise the investor. If you are looking at the stock, you see great stock, 3M, all those great stocks. And then you see, yes, but their earnings declined just 10%, 20%. Why did the stock drop so much? That's because valuations contract alongside earnings and expand alongside earnings. Here I have made a small chart. It's not perfect. But if you look at the price-to-earnings ratio, in 2005 was above 20. And during the crisis, 2008, 2009 was below 15. Those companies still had good earnings. Earnings per share cumulative of the Dow were 96 then. So the Dow was a lot cheaper than it is now. And then you see that earnings grew 40%, 50% over the last eight, nine years. As those earnings grew, the price-to-earnings ratio expanded, especially since 2015. This means that we are in the late part of the economic cycle. People don't see that it will be a cycle. And Dalio continues to mention to us that please people don't forget that economy markets everything evolves in cycles. Nevertheless, people forget about that. And you can see how in the past, 2005, 2006, price-to-earnings ratio was high. And then as earnings dropped, unfortunately didn't have the data for before, but I assume they will be higher before the crisis, 2009. So as earnings dropped, so did valuations. In the last eight years, as earnings grew, so did valuations. You have seen how the price-to-earnings ratio is high. And that should be the highest level of earnings in the late part of the economic cycle. The cyclically adjusted price-to-earnings ratio is even higher, which means that the cyclically adjusted return you can expect is lower than 4% and around 3%. And then something that shouldn't take you by surprise is to see that the valuations, the current price-to-earnings ratio of 25, contracts as earnings start to decline when we turn into the new part of the cycle. So don't be surprised to see earnings drop 40, 30, 40%, which is something normal for the great companies we are talking about. That's not much, 20, 30%. The dividends probably would stay the same. But the valuations would, too, contract 20%, 30% or from 25% to 15%. And then you have a crash, stock market crash of 50%, 60%. Even if those companies seem the best companies and the best stocks you can buy with your money. Thank you for watching. Click Like if you enjoyed the content. Comment, share your view. 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