by Chart School - October 4th, 2009 3:43 pm
If you’re at all confused about why different people report different P/E values when discussing whether or not the markets are over valued, Binve’s P/E ratio breakdown is quite helpful – without knowing exactly what numbers are going into a calculated P/E value, comparing P/Es is like comparing apples and refrigerators. – Ilene
Courtesy of Binve at Market Thoughts and Analysis
I want to review a few indicators that I was discussing in my mammoth Another Massive Chart Dump / P2 Analysis Wrap-Up post. In this post, I will be reviewing Sentiment.
Valuation – Price / Earnings Ratios:
Actually, I was discussing this topic in this post: The Long View – Aug 27, 09. Now why am I calling P/E a sentiment indicator? I posit that P/E is as much a sentiment tool as it is an objective valuation tool. And it is too high currently (as it was back in March) for a meaningful bottom.
To explain why, let’s think about what P/E means. It is the the "payback period" for a stock’s current earnings to justify/cover the current share price. Another way to look at it is the *premium* that you place on the stock’s ability to generate future earnings. Earnings theoretically grow for growing companies, or the are stable and consistent for well-run companies. But shouldn’t a P/E for a particular company or even a sector be a well-known and consistent metric? Why would anybody pay a premium on P/E?
Because investors are emotional. They fall prey to greed and fear, optimism and pessimism.
Moreover, large scale herd-behavior for optimism and pessimism actually runs in cycles. Read this article, it is a fantastic description of this valuation cycle: http://www.zealllc.com/2007/longwave3.htm. The main upshot of the article is that these long valuation waves take about 32-36 years to run, the last bottom was in 1981, and valuation bottoms do not occur until the broad market (as measured by P/E’s on the Dow or the S&P 500, which have very similar P/Es most the time) P/E is between 6-10. Long Term (100 year) average P/E is ~14.
So let’s see what the data is saying for the S&P 500. All of the data shown is taken directly from Standard and Poors: http://www2.standardandpoors.com/spf/xls/index/SP500EPSEST.XLS