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Are P/Es Too High?

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February 06, 2013 – Comments (2)

Board: Macro Economics

Author: brucedoe

One hears a lot of claims that the stock market is too "rich." They never seem to give reasons why. I'm not sure it is a good way to tell whether stocks are "rich," but P/E* is at least one way.

The P/E of the DJIA on January 31st 2013 was 15.29. Actually this number is close to average, and it is certainly no where near 2007s high of 22 (the last time the S&P500 broke through 1,400), though higher than a year ago at 14. The P/E of the S&P500 is a tad high at 18.31 and higher than a year ago at 15.11 but not screamingly so.

Interestingly the DJ Transportation Index has actually fallen from a year ago 18.31 vs 20.94 so it looks like a correction may be going on. The same is true of the Russell 2000 that has dropped to 31.65 vs 44.40 a year ago.

I admit that the DJ Utility Index does appear to be over bought at 22.18 vs 14.33 a year ago, but that is not what the hysterical comments are about.

All in all, I think this stock market has a ways to run though one might be careful of the Russell 2000 and the DJ Transportation indices where corrections seem to be going on, though the yields are improving there. The DJ Utility Index looks overbought and even the yield has dropped for some reason. However, our particular holding here of Big D (Dominion Resources) and Duke Energy seem to be performing well.

brucedoe


*See http://online.wsj.com/mdc/public/page/2_3021-peyield.html The table does not state whether the numbers are arithmetic mean or geometric mean.

A problem with P/E is that negative P/Es (or losses) are entered just as zero. If a rigorous P/E was used, something like the NASDAQ 100 might be considerably higher.

Still, the P/E for the March low in 2009 of the S&P500 was 116.31, but it was even higher on June 30th at 122.4 (http://en.wikipedia.org/wiki/Price–earnings_ratio). Actually this was a good buying point wasn't it? 

2 Comments – Post Your Own

#1) On February 06, 2013 at 11:15 AM, OceanJackson (62.59) wrote:

Nice post. I was just reading Peter Lynch's One Up On Wall Street last night actually, and chapter 10, "Earnings, Earnings, Earnings" - where he explicitly discusses that a high P/E of the Market is something to be vary wary of.

He noted the big drops of 1973-74, and 1987 were both preceded by inflated earnings. Prior to the 87 crash, the market crept from a P/E of 8, to 16.  The market hit a peak P/E of 20 in 1971.

Lynch says, "Any student of the P/E ratio could have seen that this was lunacy, and I wish one of them had told me. In 1973-74 the market had its most brutal correction since the 1930's."  

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#2) On February 10, 2013 at 7:11 PM, Zakgirl (30.86) wrote:

Interesting post.

I'd like to know hear the reasons behind comments that the "stock market is too rich" too. Easy to say, hard to verify.

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