I'll explain the earnings "normalization" process tomorrow. For now, I'll just share the first highlights to come out of this little study.
To evaluate the predictive power of the 15-year normalized P/E, I put 56 qualifying years (1935-1990) in order from the lowest 15-year normalized P/E to the highest. I then measured the compound annual point growth in the Dow over the subsequent fifteen years. Here is the 15-year compound annual point growth in the Dow when the group is divided into quarters (from lowest normalized P/E to highest normalized P/E):
And here is the same group divided into eighths:
Finally, here are the three highest and lowest 15-year normalized P/E ratios for the years 1935 – 2006:
Lowest: 1982 (6.88), 1942 (7.30), 1981 (7.59)
Highest: 1999 (30.84), 2000 (28.71), 1998 (28.05)
I'll have many more posts on this project in the days ahead. If you have any questions (or suggestions) about this project, please feel free to comment to this post – or, simply send me an email.
I'll explain the project in detail later this week. I just wanted to get this data to you first, before getting into all the boring details of how this stuff is calculated.