Every debate about the stock market ultimate boils down to one question: is it cheap or expensive?
The answer to that question depends on what metric you’re looking at.
Perhaps the most common way of considering stock market value is by looking at prices relative to expected earnings. After all, profits are the mother’s milk of stocks.
FactSet’s John Butters examines the forward 12-month price/earnings (P/E) ratio in historical context. And depending on the time frame you’re looking at, the stock market looks both overvalued and undervalued. From Butters:
The current forward 12-month P/E ratio is above both the 5-year average (13.0) and the 10-year average (14.0). The P/E ratio has been above the 5-year average since January, while it has been above the 10- year average for the past 10 weeks. With the forward P/E ratio well above the 5-year and 10-year averages, one could argue that the index may now be overvalued.
On the other hand, the current forward 12-month P/E ratio is still well below the 15-year average (16.2). During the first two to three years of this time frame (1998 — 2001), the P/E ratio was consistently above 20.0, peaking at around 25.0 at various points in time. With the forward P/E ratio still below the 15-year average and not close to the higher P/E ratios recorded in the early years of this period, one could argue that the index may still be undervalued.
The biggest problem with measuring value based on expected earnings is that those expectations usually prove to be very inaccurate.
Regardless, the debate over whether to buy or sell rages on.
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