Cramer's verdict: Are stocks insanely overvalued?

Cramer: Is the market overvalued?
Cramer: Is the market overvalued?   

The month of June has notoriously known to be an ugly one, with the Dow Jones Industrial average going negative 80 percent of the time in the past decade. Jim Cramer wondered if investors were just whistling past the graveyard on Monday with the Dow closing just slightly in the green.

Does this mean that the market is too expensive, and we are skating on thin ice?

To find out, the "Mad Money" host took an in-depth look at this concept to see if it adds any value to the investment process.

Typically, one would value the entire stock market by looking at what investors are willing to pay, called the price-to-earnings multiple. Right now, the S&P 500 is trading at about 18.5 times earnings, which is a bit high versus historical norms.

But what does that number mean anyway? Cramer has seen stocks trade at 29 times earnings and at 12 or 13 times earnings, back when there was a lot of inflation. We can't look at this number in a vacuum.

"This entire notion of 'the market' is something I balk at. When we talk about the market, we are dealing with a construct that can be very misleading," the "Mad Money" host said.

In reality, the stock market is just made up of pieces of paper that represent ownership interest in various companies. Some are expensive, some are cheap and some are in between.





Traders work on the floor of the New York Stock Exchange.
Getty Images
Traders work on the floor of the New York Stock Exchange.

For instance, Cramer has loved Apple stock and has preached the "own it, don't trade it" investment advice for this stock as long as he can remember.

Why does he love Apple stock so much? Could it be because he is completely inseparable from his iPhone or because he thinks the world will be taken over by Apple Pay? No.

It's because of its valuation. Apple sells at only 14 times earnings, which is well below the average stock on the S&P 500. It also has the biggest buyback in history and has the same yield as a five-year treasury note. Jackpot!

Even better, when you back out the cash on Apple's balance sheet the stock only trades at 12 times earnings.

"I've searched far and wide for stocks that potentially have a double-digit growth rate but still trade at just two-thirds the market multiple. That's not supposed to happen. But it has, and with a $750 billion company," Cramer added.

Or how about financials, which make up the largest part of the S&P 500? Right now, Wells Fargo only trades at 13 times earnings, and the largest international bank, JPMorgan, trades at 10 times earnings.

So if stocks were really so overvalued, how the heck are these price-to-earnings multiples so small?

"Frankly, after all of the balance sheet improvement, all of the market share gains and all of the opportunity versus what they had just seven years ago, how can these stocks be valued so low?" Cramer added.

Then there is the world of mergers and acquisitions, which has taken the market by storm lately. Three months ago specialty semiconductor company Altera sold at 25 times earnings. Then, on Monday morning, Intel announced that it would pay $54 a share in cash for Altera, and now it only sells at 40 times earnings.

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Some might think that Intel made a ridiculous overpay for Altera and that the deal doesn't make any sense. But Cramer has a hunch that the CEO of Intel, Bryan Krzanich, might know about it.

Ultimately, regardless if the market is overvalued or not, there are plenty of situations out there that could appear expensive but are worth a lot more than investors thought. In Cramer's opinion, that's just how it should be.

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