S&P 500 P/E Ratio: Still Above Long Term Lows

Warren Buffet's encouraging op-ed in the New York Times Friday may have inspired some buyers Friday morning, but after a world-wide credit crisis, weakening home prices, and the crumbling of several of the world's most prestigious financial institutions, how much will investors really be willing to pay for earnings. Shown below is the 12 month trailing P/E ratio for the S&P 500, its current level and the 5 year average. The average has been declining since the first quarter of 2004, where it peaked, but this could also be a cyclical signal that earnings will have to become much more robust before buyers are willing to bet on future earnings. A quick recession that's over before it starts (on an announced basis) would be encouraging. In any case, the market's P/E ratio is still above its long-term lows, but below any kind of inflated state and continued healthy earnings (like those of Google (GOOG) and IBM (IBM)) will be a long term positive once the fear leaves the market.

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Comments

[AussieTim:]

long term p/e is meaningless unless you take out inflation impact.

2008 Oct 19 08:33 PM

[Maurkov:]

Uh... since both p and e are in dollars, inflation cancels.

2008 Oct 20 10:40 AM

[FatPat:]

not quite, deflation kills stock prices as assets on balance sheed need to be written down earnings diminish, earning power also deteriorates

Inflation generally is better than deflation as nominal future earnings potential increases. Stock picking in inflation important as company needs to have pricing power to increase prices with costs. In inflationary scenario firms that do not have big lon-term assets fair better as inflation inflates capital expenditures.

Best scenario for stocks is small inflation.

Next to inflation the interest rate is important for p/e. That is the reason why Japan/Switzerland worldwide highest p/es. They have the lowest interest rate this translates into smaller opportunity costs for holding stocks.

2008 Dec 12 08:49 PM