Jim Cramer: Here’s How to Decide if Stocks Are Overpriced

NEW YORK (Real Money) -- Is the market too expensive? Are things overpriced? Is that what should jar us into the reality that we are on thin ice as we head charge into this notoriously ugly month where big capitalization stocks have historically been weak? Are we just whistling past the graveyard with Monday's gain?

First, let's break this concept down and then see if it adds any value to the investment process.

We try to figure out the value of stocks by looking at what we will pay, that is the price to earnings multiple for the collective earnings of the S&P 500. Right now it's about 18.5, which is a little high versus historical norms.

But what are historical norms really worth? For example, I have seen the market trade at 29 times earnings, a huge red flag that not coincidentally was where it was priced right before the crash of 1987.

I have seen it trade at 12 to 13 times earnings but that was typically when we had a lot of inflation or when we expected earnings were going to go down, not up.

So we can't look at it in a vacuum. For example, we know that we need to consider the relative worth of stocks as a whole to bonds. When I look at what I can get from the 10-year Treasury, about 2%, I have to find stocks, even with more risk, more attractive than bonds. So it stands to reason that the price-to-earnings multiple is elevated. Everything's relative. Stocks may not be a bargain but bonds are downright expensive, so I discount the 18.5x earnings issue as the cost of having such crummy competition from bonds.

Although, the entire construct of "the market" is something I balk at entirely.

The market is made up of pieces of paper that involve the ownership of different companies, and while there are some expensive stocks out there, we've got plenty of cheap ones, too, and others that are just plain in flux.

Let's deal with a couple. Today, on Twitter @JimCramer, someone was offering me "own, don't trade Apple  (AAPL)" t-shirts and it brought a smile to my face. Someone's listening.

Now, why do I reach such a charitable verdict? Is it because I like my iPhone so much that it is inseparable from me? Is it because I like my watch so much that I have ordered four of them for friends? Is it because I think Apple pay will become the de facto payment system for worldwide retail? Is it because I want to curry favor with CEO Tim Cook because he called in to our tenth anniversary show as "Tim from California"?

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