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TMFBro (< 20)

Market's P/E goes from 10 to 18 in five months

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August 17, 2009 – Comments (4)

From the Bespoke Group:

"A P/E ratio rising from 10 to 18.35 is what happens when the S&P 500 rallies 50% (the P) while earnings (E) continue to decline.... [I]f the current bull is going to have any sustainability at all, earnings will have to start growing again.  But for now, as evidenced by the skyrocketing P/E ratio, investors are paying up on the hopes of future earnings growth." 

Expensive markets can get more expensive, but at some point, price matters.

Of course, the P/E is an interesting metric, since you can measure it different ways. Rule Your Retirement contributor Doug Short measures the P/E of the S&P 500 as 161.2 as of the end of July. That's definitely not cheap. Using the P/E10 (divide the real price of the S&P 500 by the 10-year average of earnings) yields 18.1, which is closer to Bespoke's number. As the chart below shows, that puts today's market in the second quintile for priciness.

 

 

It's a reasonable price to pay for a market with robust, sustainable earnings growth. On the other hand, it seems expensive for a market in the "new normal," when companies eek out better-than-expected earnings due to cost cutting rather than top-line growth.

Robert Brokamp is the senior advisor for The Motley Fool’s Rule Your Retirement service. 

4 Comments – Post Your Own

#1) On August 17, 2009 at 3:06 PM, Imperial1964 (97.86) wrote:

Wow!  In the second quintile using 10-year average earnings?  Consider for a minute that the last 10 years has had historically high profit margins.

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#2) On August 17, 2009 at 3:06 PM, TheClub55 (< 20) wrote:

I love P/E b/c everyone has there own version of what earning are...

 I suggest checking out the earning from the source, click on the S&P earning to open the excel file.  I like the as reported earing which as of June 30th were a P/E of 127... yep you read that correctly P/E = 127.  But if you want to live in fairytale land of operating earning its still at a P/E of 25!

How do these guys figure 18?  When the owner of the index states either 127 or 25?   

Either way the earnings suggest GDP growth over 4% for each of the next for quarters... I don't see that happening, can you say "over valued"

 

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#3) On August 17, 2009 at 3:07 PM, TheClub55 (< 20) wrote:

Neverminde my last post... I just figured out how they defined earnings.  Still conclusion is the same - OVER VALUED!

 

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#4) On August 17, 2009 at 3:11 PM, awallejr (81.56) wrote:

Good chart, but I am not sure about the "hope earnings will grow" part.  Earnings last quarter were nowhere near as bad as was predicted. The revenue part was falling but profits were still positive due to cost cutting.  Assuming a pickup in economic activity (and manufacturing for example was actually up in New York), that cost cutting plus improvement in revenues off an uptick should improve earnings even more.

While I think the market got ahead of itself and is/was due for a correction, if Bernanke and the FED's expectations play out, I would expect that "E" to continue to grow, just not robustly until the housing market starts to actually rise and unemployment starts to tick down.  A multi-year process in my opinion.  But even a slow growth is better than a nasty decline.

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