UPDATING THE MARKET’S PE RATIO
Today’s chart illustrates how the recent rise in earnings as well as the the recent pullback in stock prices has impacted the current valuation of the stock market as measured by the price to earnings ratio (PE ratio). Generally speaking, when the PE ratio is high, stocks are considered to be expensive. When the PE ratio is low, stocks are considered to be inexpensive. From 1936 into the early 1990s, the PE ratio tended to peak in the low 20s (red line) and trough somewhere around seven (green line). The price investors were willing to pay for a dollar of earnings increased during the dot-com boom (late 1990s), surged even higher during the dot-com bust (early 2000s), and spiked to astronomical levels during the financial crisis (late 2000s). Currently, the PE ratio stands at a touch below 18 which is near the lowest levels that have existed since the early 1990s.
Notes:
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Whether the markets are expensive or not depends on your perspective that the 1990s were an aberration of high P/Es or were they the start of a secular trend of high multiples.I would stick with the former.
talking abt PE….. look at CRM/VMWARE/AAPL/NTFLX/BIDU, who says tech bubble burst in 1919
AAPL’s forward PE is 16. Bubble?
For 1980-2010, from the chart it looks like PE expansion contributed ~4%/year, and ~4% from profit increases. The PE expansion is probably also directly related to the interest rates. GDP growth was probably 1.5%, and the rest of the profitability was the tailwind of declining interest rates/increase in debt of. If you believe the base case of the end of the “great moderation” but no currency/fiscal crisis, i.e. range bound interest rates, then PE expansion and flat debt/GDP contribution to returns is 0. If you believe, China/India/Brazil will buy all their imports from the US and they are growing at 10%/year, then globalization may add 1%. The market as a whole doesn’t seem to offer much of a risk premium over 5-10 yr Tsys at a PE of ~20. Of course your projections may differ, these results used a professional driver on a closed track …
Since forward expectations have, at least in the past 50 years, always been made within the context of an inflationary background, is this chart even relevant? If, as TPC and a few others have been saying, we are in the midst of deflation, who says that an 18 PE represents a low? Valuation in inflationary environments and deflationary environments is an exercise in comparing apples and oranges it would seem.
If we’re truly experiencing deflation, than an 18 PE is wickedly high in my opinion.