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Jul292010

S&P 500 P/E Ratio

DateThursday, July 29, 2010 at 04:26PM

The S&P 500's trailing 12-month P/E ratio is currently just above 15.  In the first half of the bull market rally that began in March 2009, the S&P's P/E ratio rose steadily just inline with the price of the index.  If the price of the index (P) and the P/E ratio are both going higher, it means earnings are either not going up as much as price, are flat, or are going down.  In late 2009, the P/E ratio started to trend downward, dropping from 23 to 15 since last December.  Over the same time period, the index itself is basically flat, so this means earnings have increased.  A chart showing the divergence in price and P/E ratio in the middle of the bull market is shown below.

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Reader Comments (8)

Well, we had a special situation in late 2008: WRITE-OFFS and negative earnings on SPX
Quarter Earnings/share SPX 500
03/31/2009 $7.52
12/31/2008 -$23.25
09/30/2008 $9.73
06/30/2008 $12.86

And that's why Normalized earnings over a longer-term makes more sense.
http://market-vipasyana.blogspot.com/2010/07/weekly-update-s-500-10-year-normalized.html

Current P/E: 19.62 +0.14 (0.72%)
Mean: 16.37
Median: 15.74
Min: 4.78 (Dec 1920)
Max: 44.20 (Dec 1999)

Having said this, we may squeeze out some more multiple expansion if economy hangs on in Q4/into-year end.

July 29, 2010 | Unregistered CommenterVipasyana

What a wonderful financial illusion.
The market becomes "cheaper" as prices rise ever higher.
II wonder if Warren Buffet has figured this out.

July 30, 2010 | Unregistered CommenterGrahm Turner

trailing trend earnings for s and p at about 70 dollars. a historic multiple of 15 times places fair value at 1050 currently.
earnings for 2010 estimated at 82 dollars; 2011 93 dollars; 2012; 98 dollars. playing the forward earnings game always
suspect. smoothed trend earnings seems more reliable.

July 30, 2010 | Unregistered Commentermweaver

JP Morgan just raised FY EPS for SP500, so this chart goes further down to the right. A pop in the index is inevitable with the operating leverage of the group.

July 30, 2010 | Unregistered CommenterSirvasq

This quarter again, S&P 500 earnings are coming in above consensus with a beat ratio around 80%. Q2 EPS should easily exceed $20.00, 45% above last year’s $13.81 level.

This would bring trailing 12 months EPS above $73, more than 10% better than the TTM EPS after Q1, when the S&P 500 Index was around 1200, 10% higher than currently. This is a 20% decline in valuation in less than 3 months!

Fears of a double dip combined with the sovereign debt crisis in Europe right when equity markets were near fair value on the Rule of 20 basis triggered a good correction which has brought equities back in the undervalued territory.

US equities, as measured by the S&P 500 Index are currently 18% undervalued under The Rule of 20 (fair PE = 20 minus CPI). The last time there was such an undervaluation, other than in early 2009, was in August 1988 when the S&P 500 Index reached an undervaluation of 21%. One year later and 10% higher, the Index was near full value after Index EPS had risen 12%.

By itself, undervaluation should not trigger indiscriminate buying. Cheap equities can get even cheaper. But the combination of cheap equities with rising earnings and stable or declining inflation is a strong incentive to buy.

S&P 500 trailing earnings are almost guaranteed to rise another 7% during the next 3 months, even if Q3 earnings remain flat with Q2 levels. That is because Q3 2009 EPS of $15.78 will be swapped for Q3 2010 EPS likely north of $20 (current estimates are $20.72).

This means that by November 2010, TTM EPS will be $78. On that basis, and without using forward earnings, equities are currently selling at 14x EPS. With inflation in the 1.0-1.5% range, The Rule of 20 fair PE is 18.5-19, implying a 25% undervaluation.

Clearly, it would not take much positive economic news for investors to shed some of their current (justified) fears and bid stocks up to close this large undervaluation at a time when interest rates are near zero.

See the Rule of 20 chart at http://www.news-to-use.com/2010/07/us-equities-are-clearly-undervalued.html

July 30, 2010 | Unregistered CommenterDenis Ouellet

Sirvasq, you provided some very interesting links.

For the sake of completion, here's a less optimistic view on valuations I found on dshort
http://dshort.com/articles/SP-Composite-pe-ratios.html
http://dshort.com/articles/guest/Bob-Bronson-2010-04.html

July 31, 2010 | Unregistered Commenterpinkpanther

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