One of the more common and popular earnings metrics used by market prognosticators is the Price to Earnings (P/E) ratio. P/E comes in multiple flavors, but the charts below display the Trailing 12-Month P/E for the S&P 500 and its ten sectors. Trailing 12-Month P/E is the price of a stock or index divided by the stock or index's weighted average earnings per share from the previous 12 months of operations. Generally speaking, the market expects companies with a higher P/E to grow EPS significantly in the future. This justifies paying a higher price for a stock now, as the premium price will be covered by future EPS growth. Conversely, stocks with lower P/Es carry more muted market expectations of EPS growth.
Large changes in P/E can indicate a departure from historical norms in terms of expected EPS growth, or that the market is now willing to pay more for that earnings growth. For instance, during the internet stock bubble in the late 1990s and early 2000s, the S&P 500 P/E expanded to a record 44.20 as investors bid up shares in companies expecting their EPS to grow significantly. When the market crashed and investors were willing to pay less for stocks, the P/E ratio fell back towards its historical mean.
Over the last year, the S&P 500's P/E has expanded from around 15.5 to 17.01, with some variations around the generally upward trend. Some prognosticators view the current 17.01 P/E as over-valued, but it is certainly within the historical range for the US market. On a sector basis, the P/E for Health Care stocks has jumped noticeably, to 20.14. Health Care was the best performing sector last year and strength in Biotech stocks has bouyed investor optimism for Health Care early in 2014. 20 is an aggressive P/E ratio, but of more concern is the distance between Health Care's P/E and the 50-Day Moving Average (50-DMA) of the sector, which is at its widest level of the last year. A correction in the Health Care P/E over the near term would have to come from prices, as EPS are largely set for the quarter following the close of earnings season. Earnings season was a boon to the Materials sector as a sharp drop in P/E at the end of the year was halted by gains in price during the earnings season. Industrial P/Es are bang on trend around their 50-DMA and are worth watching during post-earnings price action over the coming months. Finally, Tech's P/E (17.88) is just slightly higher than the S&P 500's P/E (17.01), and four other sectors have higher valuations than Tech. We've come a long way from the internet bubble.