Jeremy Siegel's Silly P/E 26 comments
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Jeremy Siegel has an absolutely astonishing argument in the WSJ today, designed to prove that stocks are quite cheap really: he says that S&P "miscalculates" the earnings of the S&P 500, for the purpose of calculating the index's p/e ratio.
The way S&P does it, they take the aggregate market capitalization of the S&P 500 (the price) and divide it by the aggregate earnings of the S&P 500 (the earnings). Seems sensible enough to me. But Siegel has a better idea: why not ignore the companies which lose money, and just concentrate on the companies which make money? If you do that, then stocks look much less overpriced!
Siegel doesn't ignore the money-losing companies entirely. But, he says, "firms with huge losses generally have extremely low market values", and so he decides to minimize their impact in his calculations by weighting earnings according to market cap. Clever, eh? But the idea that this is the "accurate" way of totting up earnings is just silly.
Earnings don't change according to market capitalization. The p/e ratio is an interesting animal: the numerator changes from day to day and even from second to second, while the denominator changes only once a quarter. It's an indicator of how the market (the numerator) is reacting to reality (the denominator). But under Siegel's method, the denominator changes every second as well. And rather than dividing the market by reality, we end up dividing the market by itself. Which is much less useful.
Update: Paul Kedrosky weighs in:
At the very least Siegel should have recalculated the series over history to show what his new cap-weighted earnings multiple would look like. Trotting out a single adjusted figure with no context of what cheap now means in S&P 2.0 Siegel-world is meaningless.
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Larry House: Investors don't "need" anything. Some people buy stocks, some sell them, others like you just go in cash and try to convince themselves that investors "need" to see what you see. To each their own. Live by your choices but lose the attitude that you see the light and others don't.
Siegel's point is that the P/E ratios of the different components of the S&P are extremely unvensly distributed. I can see that arguing that this makes stocks "cheap" is debatable.
But if, taken to the extreme, 499 companies in the index made 100 million in a quarter, and one company lost 50 billion (as AIG did), it's pretty obvious that using the S&P's method would assign a negative P/E to the entire index, which would be ridiculous and completely irrelevant to the cheapness of the market as a whole.
I don't know that dividing by the market cap is the answer, but I can clearly see that S&P's method isn't very smart either.
User 361751 and Siegel are correct if you are trying to assess what the overall market price being paid (in the S&P 500 companies) for the overall corporate earnings -- for instance, if you were an index fund this might be a meaningful metric.
If I'm an individual shareholder deciding (using Siegel's example) a share of Exxon or a share of Jones Apparel, then the weighting doesn't do much for me, both Felix and Bespoke are correct.
Actually Siegel is right.
You say:
Earnings don't change according to market capitalization. The p/e ratio is an interesting animal: the numerator changes from day to day and even from second to second, while the denominator changes only once a quarter. It's an indicator of how the market (the numerator) is reacting to reality (the denominator). But under Siegel's method, the denominator changes every second as well. And rather than dividing the market by reality, we end up dividing the market by itself. Which is much less useful.
You're ownership of those earnings is changing with every individual wiggle of individual shares too. You just don't know it.
BTW - I don't mean to say ownership. I mean to say when you own the S&P 500, your own implied PE is changing with every market wiggle of the individual shares down below because those wiggles change each indivual companies PE ratio. When you buy the S&P 500, that is effectively what you are buying and that is what Siegel is trying to show. So yes, the denominator is always changing as a buyer of the S&P 500.
On Feb 25 06:13 PM kdo wrote:
>
> Actually Siegel is right.
> You say:
>
> Earnings don't change according to market capitalization. The p/e
> ratio is an interesting animal: the numerator changes from day to
> day and even from second to second, while the denominator changes
> only once a quarter. It's an indicator of how the market (the numerator)
> is reacting to reality (the denominator). But under Siegel's method,
> the denominator changes every second as well. And rather than dividing
> the market by reality, we end up dividing the market by itself. Which
> is much less useful.
>
> You're ownership of those earnings is changing with every individual
> wiggle of individual shares too. You just don't know it.
Measures that are useful in the case of individual equities often lose their usefulness when applied to an entire class, index, or even when used to compare industries...
Sales to book, price to book, and EPS yield for example, lose their relative usefulness when evaluating alternate energy start-ups, and the miners have always suffered from low PE ratios.
Perhaps the argument is not so much whether or not Dr. Siegel is 'right', 'wrong', or 'silly'...
I think that we might be trying to force a square peg into a round hole!
Take the simple example of an index of 2 (Companies A & B) with equal market caps. If A has earnings of $1 and B has a loss of $1 and assuming you can only distribute earnings the ability of the index to distribute earnings is $1 not $0.
How over/under priced are those company's that are making profits?
Felix, you are really grasping for attention here!!
However, for historical purposes, Siegel's argument does not help much. Changing the calculus will give us apples to oranges. Also, as these companies shrink drastically in market cap (C, BAC, etc), thier impact on the SP500 average likewise diminishes.
So in conclusion, if you look like Larry Fine, but you teach in the Ivy League, you can get published in the WSJ (but I doubt it helps pick up B girls)
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www2.standardandpoors....