Friday, July 23, 2010

Getting A Feel For The Market

To gauge how expensive the general market is, investors will often look at the market's overall P/E. Unfortunately for investors, however, the market's earnings can fluctuate dramatically. For example, S&P 500 earnings were 69 in 2007, 15 in 2008, and 51 in 2009. With earnings in a constant state of flux, how can the investor rely on the market's P/E when it is subject to such dramatic change?

In Security Analysis, Ben Graham and David Dodd advocated averaging earnings over several years to gauge a company's earnings power, and from that idea comes the concept of "PE 10", which is the P/E of the market using the current price in the numerator, and the average of the last 10 years of earnings for the index in the denominator.

Since 1880, the median and average P/E 10's of the S&P 500 have each been around 16. Currently, the S&P 500 trades at about 19 times its earnings over the last 10 years, which is well below the 44 times it reached in 1999.

One site, multpl.com, is dedicated to providing a daily update of the market's P/E 10. Readers are encouraged to visit this site from time to time when they wish to determine the relative cheapness of the broad market, as it can serve as a useful anchor amidst the media noise that attempts to predict market movements using all sorts of various, often irrelevant, data.

2 comments:

Paul said...

Saj,

another excellent post. I usually use shiller's data, but this is nice because it's updated more frequently. one point from my end though. part of me is somewhat fearful, because the market is not cheap compared to what it normally would be under these adverse circumstance. For instance, we were alledgedly going through possible depression but the shiller ratio only went to about 12-32, which isn't significatly lower than the 16 average. I've heard the market may not get back to the lows again like in the 70s and early 80s of around 8 because people know the future returns are likely to be much higher and won't let the prices get that low. I hope my rambling makes some sense! :)

Saj Karsan said...

Thanks, Paul!

Yeah I agree that the market doesn't appear to have dropped to the relative depths that it has in recessions decades ago. It could be because we haven't seen this type of of easy monetary policy before, but I don't know. Anyway, it's nice to know where the general market is but too tough to predict, so I avoid trying to do that.

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