Are share prices still too high?

Abstract

The current value of the dividend yield is at a historically low level. Since the end of the bear market in 2003 prices have rebounded strongly such that this yield is at a lower point than any previous in its history except at the height of the late 1990s bubble. The price-earnings ratio paints a similar picture and raises the issues of equity overvaluation and price falls. This paper resolves to examine whether prices are over-valued by arguing that such measures do not have a single attractor point and hence relying on historical means as a guide to mis-valuation is not a valid approach. In explaining why the higher equity prices relative to dividends are supported we provide evidence consistent with existing arguments that low and stable inflation is a particular driver to better equity valuation and note that the last decade has seen a period of historically low and stable inflation. Hence, the stable economic environment has led to more accurate valuation of stocks and lower required rates of return, thus supporting higher prices.