S&P 500 PE Ratio at record 120

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Farmer Brown's picture
Farmer Brown
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Posts: 1503
S&P 500 PE Ratio at record 120

I heard Marc Faber in a recent interview say the SP500 PE Ratio was at 120.  Below is a chart showing this. (came from here:http://www.chartoftheday.com/20090522.htm )  

I would appreciate any insights on this from the chart experts on this site, especially in terms of any fundamental flaws with which the data might be being plotted.  If this is a true reflection of valuations, then the bear-market-trap picture couldn't be any clearer.

 

 


Chart of the Day Bookmark and Share

Last week's chart illustrated the current plunge of S&P 500 earnings. Today's chart illustrates how this plunge in earnings 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 late 1980s, 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) and the dot-com bust (early 2000s). As a result of the current plunge in earnings and the recent 2.5 month stock market rally, the PE ratio has spiked to the low 120s – a record high.

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mpelchat's picture
mpelchat
Status: Silver Member (Offline)
Joined: Sep 10 2008
Posts: 214
Re: S&P 500 PE Ratio at record 120

A definition:

What Does Price-Earnings Ratio - P/E Ratio Mean?

A valuation ratio of a company's current share price compared to its per-share earnings.



Calculated as:



Price-Earnings Ratio (P/E Ratio)
 



For example, if a company is currently trading at $43 a share and earnings over the last 12 months were $1.95 per share, the P/E ratio for the stock would be 22.05 ($43/$1.95).



EPS is usually from the last four quarters (trailing P/E), but sometimes it can be taken from the estimates of earnings expected in the next four quarters (projected or forward P/E). A third variation uses the sum of the last two actual quarters and the estimates of the next two quarters.

 

Also sometimes known as "price multiple" or "earnings multiple". 
 
Investopedia Says
Investopedia explains Price-Earnings Ratio - P/E Ratio

In general, a high P/E suggests that investors are expecting higher earnings growth in the future compared to companies with a lower P/E. However, the P/E ratio doesn't tell us the whole story by itself. It's usually more useful to compare the P/E ratios of one company to other companies in the same industry, to the market in general or against the company's own historical P/E. It would not be useful for investors using the P/E ratio as a basis for their investment to compare the P/E of a technology company (high P/E) to a utility company (low P/E) as each industry has much different growth prospects.

 

The P/E is sometimes referred to as the "multiple", because it shows how much investors are willing to pay per dollar of earnings. If a company were currently trading at a multiple (P/E) of 20, the interpretation is that an investor is willing to pay $20 for $1 of  current earnings.



It is important that investors note an important problem that arises with the P/E measure, and to avoid basing a decision on this measure alone. The denominator (earnings) is based on an accounting measure of earnings that is susceptible to forms of manipulation, making the quality of the P/E only as good as the quality of the underlying earnings number.
Ragnar_Danneskjold's picture
Ragnar_Danneskjold
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Re: S&P 500 PE Ratio at record 120

Annualized earnings reported for the ENTIRE S&P 500 last quarter were a little less than $8.  If the S&P 500 were actually priced to that earnings level, it would probably be below 150.  For some inexplicable reason, the market believes the S&P 500 will earn $50+ next year, which is basically a little less than the S&P was earning prior to the 2007 crash.   What would it say if the S&P earned $50+ with a 10%+ reduction in employment?  

JAG's picture
JAG
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Posts: 2492
Re: S&P 500 PE Ratio at record 120

 Patrick,

I think John Mauldin has a nice analysis on the usefulness of P/E ratios in his Feburary 27, 2009 newsletter Buy and Hope Investing

Based on 2008 as-reported earnings, the S&P 500, which closed at 735 today, has a trailing P/E of 52. The forward P/E, based on 2009 projected earnings, is 22.7. But the trailing 12-month P/E for the end of the second quarter, based on the last half of 2008 and projections for 2009, is a nosebleed 51.2. (The combination of actual and projected earnings is $14.36 per share.) Mind you, that is after a rather healthy drop in the price of the index!

In his op-ed, Jeremy says that looking at the earnings for the entire index can be misleading. "What this dismal news actually reflects is the bizarre way in which the S&P (and most other index providers) calculate "aggregate" earnings and P/E ratios for their indexes. Unlike their calculations of returns, S&P adds together, dollar for dollar, the large losses of a few firms without any regard to the market weight of the firm in the S&P 500. If they instead weight each firm's earnings by its relative market weight, identical to how they calculate returns on the S&P 500, the earnings picture becomes far brighter."

He uses the illustration of Exxon and Jones Apparel Group, the largest and smallest, respectively, two stocks in the index. Exxon has a weighting 1,381 times that of JAG. If by some chance one made $10 billion and the other lost $10 billion, the effect on aggregate earnings would add up to zero. But if you counted earnings relative to size, you would get a much different picture.

There are 80 companies which had a combined (so far) loss of $240 billion in 2008, which takes about $27 per share of the total earnings, although these companies only account for 6.4% of the index. If you figured earnings by market capitalization, you would get earnings at $71.10, says Jeremy. At today's close, that makes the P/E closer to 10! And that does sound better than my analysis above. He concludes:

"No one can deny that the recent economic downturn has badly hurt corporate earnings. But let's not fool ourselves into thinking that this is an expensive market. When computed accurately, P/E ratios show that this market is much cheaper than is currently being reported by the S&P. Those who venture into today's stock market are indeed buying good values."

So which is it? A P/E of 10? Or 20? Or 50?!?!? Who is fooling whom?

First, let me state unequivocally that there are stocks in the S&P 500 that are good values. If you buy them today you will be rewarded in the medium and long run. Don't ask me which ones, because I don't do stocks -- I have enough on my plate looking at investment managers and the economy. But there are value managers who will do well from this point. The fact that they have been hammered by 50% or more in the past year is another story for another letter. (But nearly all of them made the case that "today" was a good time to buy their fund and did so every day for the last year.)

I think there are some problems with Jeremy's methodology. Do you weight CITI, for instance, at their market cap at the beginning of the quarter, or at the end? AIG? B of A? That could make a huge difference. And what about when the financials were contributing so much to earnings just a few years ago?

Financial stocks were 22% of the index at their highs, and an even greater share of the earnings. They are now down to 10%, and Mary Ann Bartels of Bank of America thinks they will slip to 7%. Using Jeremy's methodology, one would overweight their earnings in the go-go years and then all but ignore their losses this last year as they slipped 78% (and still falling).

cmartenson's picture
cmartenson
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Re: S&P 500 PE Ratio at record 120

Edit - Sorry Patrick, you pasted in content that linked to a subscriber service and I had to delete your post to remove the link.

When copy/pasting it's best to follow a few simple rules:

  1. A snippet only and a link - please no full articles or anything that would violate copyright laws.
  2. Copy but only paste after switching to plain text editor by toggling the link directly below the comment/edit window that reads "Switch to plain text editor."  This way lots of potentially disruptive formatting will not follow the words from their source be that another web page a word doc (or anything else that applies formatting to text).

Thanks in advance!

Chris Martenson

FinPro's picture
FinPro
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Joined: Oct 20 2009
Posts: 49
Re: S&P 500 PE Ratio at record 120

Look.  Faber was the same one who just said gold won't go below $1000 ever again.  So, balance one extreme with the other and you have a P/E of 120 for the S&P.

P/E's are an extension of the first thing the textbook types learn about stock valuation, which is the dividend discount model.  There you put dividends over a required rate of return to get stock price, or P = D/E.  Algebra gets you to P/E.  Actually, the same type of valuation tool is used to 'cap rate' commercial real estate, where income produced goes over a desired return, or more specifically is used to impute the Cap Rate where the asking price and income prospects are known.  (Cap rates and commercial real estate are way high, right now).

I'd argue Faber hasn't got a clue, but I don't like gold, either.  The consistent view for stocks, if I wanted you to invest in them, would be to tell you that P/E's are low when priced above what would be an ordinary earnings recovery which proceeds an employment/economic recovery.  The problem with P/E's is everyone gets mired in one year forward/backward calculations.  The probable earnings growth will drive prices higher because there are still enough of us Graham and Dodd types who see fundamental value in improving earnings ability.  Its the antithesis of technical analysis and doesn't work for banks because, well, they aren't transparent and who knows what "good" capital is anymore.

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