### Is the market Undervalued - A look at the S&P P/E Ratio

July 05, 2010
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There's been a sharp increase in bearish posts lately. And probably for good reason considering the economic numbers on unemployment, sovereign debt, and housing sales numbers. But I get tired of all this gloom and doom and like to sit back and look at the numbers. A 'reality check' so to speak.

Let's face it - it's corporate earnings that ultimately drive stock prices. While the P/E ratios may swing about anywhere from 10-30 depending on how bearish or bullish the market is - it ultimately swings back to some happy medium.

Now for a look at the numbers. If you have never been on the S&P website - I advise you to check this link out http://www.standardandpoors.com/home/en/us You need to register to get access to the data but it's free and well worth it. One spreadsheet I like to look at is the S&P500 EPS estimates. There's some nice historical data to look at here. Data is shown on a quarterly basis going back to 1988. Quarterly PE numbers on an "Operating" basis varies anywhere from 11.51 to 29.55. Doing a little statistical analysis the median PE since 1988 is about 18.23.

Let's look at the estimates for the year as they stand today. 1st quarter is already in at $19.41. 2nd, 3rd and 4th quarters are $19.61, $20.70 and $22.01 respectively. Total estimated earnings for the year is $81.73. This would be a 44% rise over 2009 earnings of $56.86. The numbers look even more attractive when you consider how conservative these estimates are. If you go back a few quarters and look at the estimates you will find that they are frequently low by as much as 50%.

Even if we assume the estimates are not low the PE ratio based on this number is a very low 12.61. This is close to the PE ratios we have seen only back in the late 80's. I believe this is too low a number considering how low interest rates are. Once we regain a little confidence in the market again I think we can return to more normal PE ratios in the future.

What are my predictions? Given current conservative (and most likely low) earnings estimates of $81.73 and a worst case scenario depressed PE of about 15 we should still have a S&P year end around 1225. If market sentiment improves and we get some positive economic news ----LOOK OUT!--- we could easily see S&P numbers as high as 1450 year end. Gotta love the market!