Wednesday, August 22, 2012

Market Sentiment

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 66 in 2007, 15 in 2008, 51 in 2009, and 77 in 2010. 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. 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, both the median and average PE 10 of the S&P 500 have been around 16. Currently, the S&P 500 trades at about 22 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,

Do you know any place that keeps a record of total market cap relative to GNP? There is this on gurufocus, bu this is GDP.

http://www.gurufocus.com/stock-market-valuations.php

Saj Karsan said...

Hi Paul, I do not!