Just as Charlie Brown cannot resist a football teed up in Lucy's hand, so cannot the perma-bulls resist saturating the financial news after a meaningful bear market rally.

We get the usual team of strategists, like Charlie Brown, running down the field attempting to kick off a new bull market. Unfortunately, the stock market tends to pull a Lucy and take away the ball right before the fun starts. Tom, Abby, Joe, Ed, Don and the others are as prone to be disappointed in their kickoff attempt as Charlie Brown himself. Stock market valuation levels will be the major culprits in their whiff.

Dismissing the Case for Cheapness

I realize that stock prices have come down quite a bit in the past few months. Many analysts, portfolio managers, financial journalists and strategists, not just the perma-bulls, contend the market is cheap. Their case rests on the assumptions of much higher normalized profits, low inflation and interest rates, and some kind of earnings discount model.

But their case for cheap valuations clearly ignores historical absolute levels such as price-to-earnings, price-to-book value, price-to-dividends and price-to-sales ratios. Current P/E ratios are dismissed because of the recessionary earnings, book values are dismissed as obsolete, and dividends as irrelevant. Because of the perceived shortcomings in most traditional valuation measures, bullish investors can claim that shares are cheap without supporting statistical evidence.

But let's take a look at the market's price-to-sales ratio, a valuation measure that's hard to dismiss.

Lofty Levels
The S&P 400 sports a relatively high price-to-sales ratio
Sources: Marcin Asset Management, MSIM

As you can see from this chart, the S&P 400 has traded around 140% of sales at bull market peaks and around 40% of sales at bear market troughs. That is, until the bubble of 1998-2000, the one that Greenspan could not identify. Then it traded up to 235% of sales, far surpassing any prior bull market level.

Despite the vicious bear market of the past few years, the large-cap S&P 400 still trades north of 125% of sales. Over the past 75 years, this valuation level has been more closely associated with a bull market top rather than a bear market bottom. I would like to hear from the "Charlies" out there on how this parameter represents an undervalued stock market.

Parsing the Price-to-Sales

One can also use the price-to-sales ratio to better understand the normalized P/E of a company or index. A price-to-sales ratio divided by a profit margin is a company's P/E. It is critical to disaggregate a company's P/E into a price-to-sales and a profit margin. One can then adjust for cyclical profit margins or pass better judgment regarding profit margin sustainability.

Over the past 30 years, the average net profit margin for the S&P 400 has been 5%. It had been in secular decline since the 1950s, except for the bubble, of course, where free money contributed to oversized profits. Currently, margins are depressed because of the bust in capital spending, but they will eventually recover.

A few sophisticated strategists I respect think it will average 5% to 6% over the long term. If they are correct, the current P/E ratio on the S&P 400 is 125% (the price-to-sales ratio) divided by a range of 5% to 6% net margins, or 21 to 25 times profits. Stocks are hardly cheap, despite what Ken Fisher maintains about the meaninglessness of P/E ratios.

There are sound reasons why stocks should not retreat to traditional bear-market valuation levels of 40% of sales. Namely, to cause this valuation it took a depression in one case (the 1930s) or runaway inflation and interest rates (1974-1982) in the others. In my opinion, neither outcome is likely.

However, the current valuation level is not one from which bull markets have historically sprung. In fact, the S&P 400's price-to-sales ratio traded below 100% every year from 1925 through 1995. Before this bear market ends, I could envision the market trading down to a range of 80% to 100% of revenue, or another 20% to 30% decline.

The devastation in the stock market in the past few months has created some decent opportunities. Many small- and mid-sized companies with good fundamentals have been crushed and now represent decent value. I have begun to buy stocks again in companies that fit my investment discipline. My long ideas will follow in other columns.

Stocks are definitely cheaper these days than they have been the past few years. But absolute undervaluation? The market's price-to-sales ratio strongly suggests otherwise. Sorry, "Charlies."
Robert Marcin is the principal of Marcin Asset Management, a private investment firm. Formerly, Marcin was a partner at Miller, Anderson & Sherrerd and a managing director at Morgan Stanley, where he managed the MAS Value fund (currently Morgan Stanley Institutional Value). At the time of publication, Marcin had no positions in any of the securities mentioned in this column, although positions may change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Marcin appreciates your feedback and invites you to send it to robert.marcin@thestreet.com.