The S&P 500 index has had quite a run since its March 2009 bottom. It hit bottom at 666 points on March 9th, 2009 and has powered 94.5% higher to 1,249 today.
I think it’s time to reexamine the S&P 500 PE ratio. Are we closer to a market top or a market bottom? The price to earnings ratio for the S&P 500 is currently 18 (http://www.decisionpoint.com/tac/Swenlin.html ). It has been around or above 20 since 2003. I don’t think that the market is anywhere near the value level.
Time for a little price to earnings ratio history lesson. The following excerpt comes from the book Security Analysis (2nd Edition) pg. 536 and it is enlightening 71 years later.
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In previous chapters various references have been made to Wall Street’s ideas on the relation of earnings to values. A given common stock is generally considered to be worth a certain number of times its current earnings. This number of times, or multiplier, depends partly on the prevailing psychology and partly on the nature and record of the enterprise. Prior to the 1927-1929 bull market ten times earnings was the accepted standard of measurement. More accurately speaking, it was the common point of departure for valuing common stocks, so that an issue would have to be considered exceptionally desirable to justify a higher ratio, and conversely.
Beginning about 1927 the ten-times-earnings standard was superseded by a rather confusing set of new yardsticks. On the one hand, there was a tendency to value common stocks in general more liberally than before. This was summarized in a famous dictum of a financial leader implying that good stocks were worth fifteen times their earnings.1 There was also the tendency to make more sweeping distinctions in the valuations of different kinds of common stocks. Companies in especially favored groups, e.g., public utilities and chain stores, in 1928-1929, sold at a very high multiple of current earnings, say, twenty-five to forty times. This was true also of the “blue chip” issues, which comprised leading units in miscellaneous fields. As pointed out before, these generous valuations were based upon the assumed continuance of the upward trend shown over a longer or shorter period in the past. Subsequent to 1932 there developed a tendency for prices to rule higher in relation to earnings because of the sharp drop in long-term interest rates.
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This chart confirms that there has been a change in investor valuation of common stocks over the years. The bottoms of S&P 500 has been rising. Too bad the chart cuts off in 2003.
How low did the S&P 500 P/E ratio fall to during the Panic of 2008-2009?
It didn’t fall during the panic. On the contrary, it skyrocketed because earnings were falling faster than stock prices. It has settled in the 18-20 PE range since the end of 2009. Dividend yields tend to be highest at market bottoms. The last time the S&P 500 yielded over 6% was in 1982. We are closer to the top of the market than the bottom. If you are in the market, then you should make plans to get out before the next financial crisis.
Current price to earnings ratios of stock mentioned often on this blog:
American Capital Agency Corp. (AGNC) – 4.00
SafeBulkers Inc. (SB) – 4.98
SeaDrill (SDRL) – 13.70
Terra Nitrogen (TNH) – 13.51
AGNC and SafeBulkers are high dividend stocks in the value zone, but only SafeBulkers has earning power and a strong balance sheet.
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Be seeing you!
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