Yesterday, we noted that Wharton professor Jeremy Siegel’s “fair value” estimate for the S&P 500 is a startling 1380, which is about 40% higher than most other estimates (Robert Shiller, Jeremy Grantham, Andrew Smithers, John Hussman, et al). Prof Siegel, who is now a pitch man for WisdomTree funds, uses this estimate to conclude that stocks are “dirt cheap.”
The other experts, meanwhile, who use a consistent, historically predictive, and fully explained methology, estimate that fair value is around 900-1000, about where we are now. In their view, stocks are just fairly valued.
So who’s right?
In our opinion–and the opinion of one of the smartest money people we know (also a PhD)–Shiller, Grantham, Smithers, et al. are right and Siegel is wrong. Our credentialed friend also examined Siegel’s analysis and then explained what he believes is Siegel’s mistake.
Prof Siegel bases his estimate on two variables:
- “Trended S&P 500 earnings” of $92
- PE of 15
Multiply these together, and you get the 1380 fair value estimate.
Prof. Siegel’s error, it appears, is in using a PE that is too high.
The 15X average PE for the S&P 500 is what you get when you use professor Shiller’s methodology, which averages 10 years of trailing earnings (and, therefore, if profit margins are normal, uses earnings of about 4 years ago). Prof Siegel’s earnings estimate, meanwhile, is a forward estimate–one that adds about 5 years of trended growth (6% a year) to the Shiller estimate, but uses the same PE.
We suspect that, if Prof Siegel performed the same “trended” analysis over the entire 20th Century, the average PE for forward trended earnings would be about 11X-12X, not 15X. This, we expect, would produce a fair value estimate much closer to that of Shiller, Grantham, Smithers, et al. Shiller’s PE analysis is below:
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