Long-Term Cash Flow Measure Says US Stocks are Overvalued


Stock prices have been risky when they have grown faster than corporate cash flow (1998-2000, 2007, 2017) and attractive when cash flow has risen faster than stock prices (1994-1997, 2001-2006, 2009-2014).

W5000 vs Cash Flow

Short-term stock prices trends are largely driven by investor sentiment, but long-term prices correlate with corporate cash flow retained to grow the value of the business.  The chart shown above illustrates the gaps when sentiment was overly optimistic or pessimistic relative to value generation.  The technology bubble demonstrated that overvaluation can persist and expand for several years, but share prices cannot escape from the financial gravitational force pulling them back towards cash flow.


The chart was created here at the St Louis Fed site.  Changing the starting point or using a log scale can move the lines a bit, but the basic story is unchanged, stock prices rose a lot in the past 7 years and net cash flow rose a little.

The Wilshire 5000 Index measures the capitalization weighted performance of all 3492 US equities with readily available price data.

Corporate Net Cash Flow with IVA measures cash retained by all private corporations.  IVA (Inventory Valuation Adjustment) adjusts profits to value cost of goods sold at replacement cost rather than historical acquisition cost.  IVA removes the impact of price inflation on inventory held from prior periods.  Net Cash Flow is after dividends and capital expenditures so cash flow surges during recessions when companies become conservative and weakens over the course of a lengthy boom as managements become bolder and more careless.


3 thoughts on “Long-Term Cash Flow Measure Says US Stocks are Overvalued

    1. I think investors should be prepared for a bear market to begin within 3 years. Calling market tops is hard, but I believe that investors can prepare by holding more cash and becoming more cautious towards highly leveraged and cyclical companies.


Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s