Market's P/E Ratio Surges: What Does This Mean?

Here's a look at the S&P 500 (black line, left scale) and its earnings (gold line, right scale).

The two axes are scaled at 16-to-1 so when the lines cross, the market's P/E Ratio is 16. I think we're at an interesting point where the stock market's P/E Ratio doesn't tell us much. The market has clearly sensed signs of recovery even though earnings are still plunging. As a result, the market's P/E Ratio has jumped about 50% since March.

Does this mean that stocks are valued 50% more favorably? Not at all. I think the market is getting a better sense of where earnings will bottom. Analysts currently see earnings reaching a trough of about $38 for the third quarter. I can't say if that's right but it does seem reasonable.

The fourth quarter of 2008 was awful so once we get that behind us, the trailing earnings picture will look much better. According to S&P, AIG took out over $5 all by itself. The current outlook is that the S&P 500 will earn $54 for 2009. That strikes me as high but not out of reach.

For 2010, Wall Street sees earnings of $73.56. At 16 times earnings, that means an S&P 500 at 1177 which is about 25% higher than we are now.

One other point to note: Analysts have not been very good at getting earnings right. In a few weeks we'll close the books on Q2. One year ago, Wall Street was expecting Q2 earnings of $26.73. Now they're expecting just $13.49.

Disclosure: No position

Comments

[Fighting Yoda:]

PE ratios for S&P are fantastic. Despite the fact earnings foreacts are coming down S&P is moving up (so much for green shoots).

S&P Top down Operating earnings estimates as compiled and published by Standards and Poors
2009 – Estimates
03/22 – $49.09
04/20 –$ 44.40
05/20 – $42.93
6/3- $42.98 PE: 21.9

Reported Earnings 2009 estimate $27.45 - PE: 34.3

2010 - $46 - PE: 20.5

Jun 10 01:55 AM

[Jasper M:]

Future earnings are always something of a pig in a poke. Doubly so when the real world economics go out the window, in favor of fantasy. There is No Way the S&P will earn $70+ in 2010.

Jun 10 03:17 AM

[Mad Hedge F...:]

It means we've gone nuts again. The market has gotten so dead here that I have started watching Suzie Ormand to get trading ideas. So I’m not supposed to run large balances on my credit card? Who knew? A hedge fund friend told me that the market is now like watching a ball tossed in the air that is at the apogee of its move, just before the free fall begins. No news, with shrinking volume and volatility. General Motors (GM) isn’t a stock anymore, so all of the news flow there might as well be a History Channel documentary. You can only sell so many out of the money short dated calls on other stocks before bumping up against risk control parameters. Even if you do make money in these conditions, it is at the expense of a Maalox addiction to fight the multiple holes in your stomach. It’s not worth it. This is why I prefer to spend my summers mountain climbing or practicing my ballroom dancing. Please see my “Sell in May and Go Away” opus at (www.madhedgefundtrader...

Jun 10 10:58 AM

[Fighting Yoda:]

Analyst estimates made are of several types - Top Down, Bottoms Up - Operating earnings, reported earnings. Reported earnings are difficult to forecast - due to the fact - they are based on subjective decisions of managements - to take certain charges (or gains) or not, when , how much; Also reported earnings get impacted by one time (or non repeatable events). Market typically follows operating earnings - the earnings as generated by business in its normal course excluding onetime events (gains or losses).

For next year forecasters are estimating there would be onetime gains due to write-ups etc. That may or may not happen, unlikely in my opinion. The $ 73.56 mentioned by the author is Top Down reported earnings. This is not followed by the market - TV/media etc.
Top Down vs. Bottoms up – again market follows Top Down – typically they are more accurate historically (you can take the average if you prefer).

Here are all the estimates:
Top Down Operating earnings Estimates earnings- $46
Top Down Reported earnings Estimates earnings- $35.67
Bottoms up Operating earnings Estimates – $73.56

All time historical S&P PE – 16, bear market PE – 10 and below.

Jun 10 01:19 PM

[vvvvviking:]

Operating earnings are a joke. Like all those writeoffs are "one time" events. until they happen again next year,and next year...

Jun 10 01:37 PM

[InnocentsAb...:]

900/ $27.45 = 32.8. Sounds like the PE ratio of an optimistically evaluated high tech. growth stock with good prospects.

At a 3% earnings yield, 10 year bonds sound like a better bet. (IMHO).

Jun 10 03:00 PM

[Alphameister:]

On a long-term basis, the two charts should be superimposed with a lag of six to nine months for a more soundly based analysis.

Jun 10 05:13 PM

[otishertz:]

The PE for the S&P 500 is 130 using twelve months trailing earnings according to barron's here:

online.barrons.com/pub...

Operating earnings PE is bullshyte.

Jun 11 04:16 AM

[otishertz:]

I looked into the PE on the SP500 for a couple of weeks recently. It is 130. Even e-mailed the WSJ and Bloomberg about claiming it was 15, then 14, then 13.

See it here at WSJ.com without any mention of it being operating earnings:

online.wsj.com/mdc/pub...

You can read about what I learned and have a link for another site that found all the same things here:

blog.screaminghighway..../

Jun 11 04:24 AM

[Jason Tillberg:]

Thanks for that link. I was looking for what the book value of the Dow Jones was. 3115, that's sounds like a good bottom at which time gold will be about $3,000.


On Jun 11 04:16 AM otishertz wrote:

> The PE for the S&P 500 is 130 using twelve months trailing earnings
> according to barron's here:
>
> online.barrons.com/pub...
>
>
> Operating earnings PE is bullshyte.

Jun 11 07:15 PM

[Jason Tillberg:]

I would prefer a more objective approach from someone to provide what the offical P/E ratio of the trailing 12 months earnings on the S&P are.

I want to say authoritative, but that I'm afriad doesn't exist.


On Jun 11 04:24 AM otishertz wrote:

> I looked into the PE on the SP500 for a couple of weeks recently.
> It is 130. Even e-mailed the WSJ and Bloomberg about claiming it
> was 15, then 14, then 13.
>
> See it here at WSJ.com without any mention of it being operating
> earnings:
>
> online.wsj.com/mdc/pub...
>
>
> You can read about what I learned and have a link for another site
> that found all the same things here:
>
> blog.screaminghighway..../

Jun 11 07:27 PM

[David Van K...:]

"Market's P/E Ratio Surges: What Does This Mean?"

This question has a simple answer: The P/E ratio is based on trailing, reported earnings. Starting about a year ago, company earnings began to decline as a result of the recession. Even if the price of every stock stayed constant, the P/E ratio would be going up, because the denominator in P/E is going down. It's simple mathematics.

In last year's fourth quarter, bank writeoffs of toxic assets took the earnings for the entire S&P 500 negative. That quarter is still in the calculation of the P/E ratio. As early 2009 earnings are way down from the same quarter a year ago, they are less able to counteract the negative earnings from the fourth quarter 2008. As each new quarter in 2009 replaces the year-old quarter from 2008, the impact of the negative fourth quarter in 2008 will become larger and larger on the P/E calculation. The P/E ratio will skyrocket. This phenomenon will continue until the fourth quarter of 2008 drops from the calculation...in early 2010 as results for the fourth quarter of 2009 get reported and worked into the calculation).

Jul 02 12:03 PM