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"page_name": "Stock Analysis Using the P/E Ratio | Charles Schwab",
"page_url": "https://www.schwab.com/learn/story/stock-analysis-using-pe-ratio",
"page_snippet": "Find out what traders should look for and look out for with the price-to-earnings ratio (P/E ratio).Find out what traders should look for and look out for with the price-to-earnings ratio (P/E ratio). There are two key factors that influence a stock's performance: the profitability of the underlying company and how investors value that profitability. An earnings report can tell you about the profitability part but not the value that investors place on those profits. One way to determine a stock's value is by comparing its share price to the company's earnings, a measurement known as the price-to-earnings ratio (or P/E for short). An earnings report can tell you about the profitability part but not the value that investors place on those profits. One way to determine a stock's value is by comparing its share price to the company's earnings, a measurement known as the price-to-earnings ratio (or P/E for short). The earnings per share (the \"E\" part of the equation) has remained at $5, but because of investors' optimism, the average P/E ratio rises from 16 to 20. Conversely, when investors' perception of a stock worsens and they are looking to pay less for a dollar's worth of earnings, P/E contraction occurs. The stock's price falls (even though the earnings per share remains stable) and the P/E ratio moves lower. And while its P/E may or may not represent an excellent value at that price, the stock may not rebound in any meaningful way until investors perceive there to be some catalyst. In addition, there can be situations where a company has a low P/E ratio simply because its future earnings prospects are dim.",
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There are two key factors that influence a stock's performance: the profitability of the underlying company and how investors value that profitability. An earnings report can tell you about the profitability part but not the value that investors place on those profits. One way to determine a stock's value is by comparing its share price to the company's earnings, a measurement known as the price-to-earnings ratio (or P/E for short).
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\n Components of P/E ratio\n
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The P/E for a stock is computed by dividing the price of a stock (the \"P\") by the company's annual earnings per share (the \"E\"). If a stock is trading at $20 per share and its earnings per share are $1, then the stock has a P/E of 20 ($20/$1). Likewise, if a stock is trading at $20 a share and its earning per share are $2, then the stock is said to be trading at a P/E of 10 ($20/$2).
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Enthusiasm on the part of investors can lead to P/E expansion\u2014a period when investors' perceptions of a company improve, and as a result, they are willing to pay more for a dollar's worth of earnings. For example, let's say a stock that was trading at $80 per share is now $100 per share. The earnings per share (the \"E\" part of the equation) has remained at $5, but because of investors' optimism, the average P/E ratio rises from 16 to 20.\u00a0
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Conversely, when investors' perception of a stock worsens and they are looking to pay less for a dollar's worth of earnings, P/E contraction occurs. The stock's price falls (even though the earnings per share remains stable) and the P/E ratio moves lower.\u00a0
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\n How to analyze a stock using the P/E ratio\n
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As a result of all this, companies and industry groups generating the same level of earnings per share can be awarded very different P/E ratios. For example, two companies may both report earnings of $2 per share, but the stock trading at $20 a share has a P/E ratio of 10 while the other trading at $30 a share has a P/E of 15.
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This can be due in part to the consistency of earnings, the anticipation for increased earnings, and the industry group that each stock is in. If investors are excited about the prospects for a given company, they may be willing to accept a higher P/E ratio in order to buy its shares. On the other end of the spectrum, if investors feel that future earnings will be underwhelming, a stock's P/E ratio may languish at a relatively low level.
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The key is to look at whether the current P/E ratio for the stock of a given company is presently \"high\" or \"low.\" The tricky part is that there are arbitrary cutoff levels that qualify as \"high\" or \"low.\" The best way to assess a company's P/E ratio is by:
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Comparing the company's current P/E to its historical P/E range
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If appropriate, comparing the company's current P/E to that of similar companies in the same business or industry group
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In general, if the company's current P/E is at the lower end of its historical P/E range or below the average P/E of similar companies, it may be a sign that the stock is undervalued\u2014regardless of recent business performance.
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\n What to watch for\n
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The best-case scenario for any stock is for the underlying company to consistently grow its earnings and for investors to become enthusiastic about the company's long-term prospects and to value its earnings at a high level\u2014resulting in an above average P/E ratio. That being said, emotional buying and selling at the extremes can force stocks into overbought or oversold levels.
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When a company's P/E ratio falls, a stock can become relatively \"cheap.\" And while its P/E may or may not represent an excellent value at that price, the stock may not rebound in any meaningful way until investors perceive there to be some catalyst. In addition, there can be situations where a company has a low P/E ratio simply because its future earnings prospects are dim. This can create a \"value trap,\" where a stock looks cheap by comparison but demonstrates in the future that there was a reason for its low price.
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If a stock's price rises, you need to pay close attention when a stock gets bid up to an excessively high P/E level. In the heat of a bull market, it's not uncommon to find \"hot\" stocks trading at a P/E of 50 or more. While this can go on for some time, eventually the stock's price may drop. And when a \"hot stock\" falls out of favor, the ensuing price decline can be swift and painful.
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\n The bottom line\n
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The P/E ratio can tell you a great deal about what investors overall think of a given stock. However, to accurately assess whether a stock is relatively overvalued or undervalued, it's necessary to compare the current P/E to that stock's previous P/E ratios as well as the P/E ratios of other companies in the same industry.
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Likewise, while exceptionally low or high P/E ratios can highlight potential opportunity or a potential danger, stocks can sometimes continue to move to increasingly undervalued or overvalued levels for an extended period of time before things reverse. Do your research or consult a financial advisor before making a trade.
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The information here is for general informational purposes only and should not be considered an individualized recommendation or endorsement of any particular analysis or investment strategy.
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The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.
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All expressions of opinion are subject to change without notice in reaction to shifting market or economic conditions. Data contained herein from third party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.
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Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.\u00a0
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Investing involves risk including loss of principal.
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Past performance is no guarantee of future results.
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"page_last_modified": " Wed, 28 Feb 2024 16:24:51 GMT"
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{
"page_name": "Price\u2013earnings ratio - Wikipedia",
"page_url": "https://en.wikipedia.org/wiki/Price\u2013earnings_ratio",
"page_snippet": "The price\u2013earnings ratio, also known as P/E ratio, P/E, or PER, is the ratio of a company's share (stock) price to the company's earnings per share. The ratio is used for valuing companies and to find out whether they are overvalued or undervalued.The price\u2013earnings ratio, also known as P/E ratio, P/E, or PER, is the ratio of a company's share (stock) price to the company's earnings per share. The ratio is used for valuing companies and to find out whether they are overvalued or undervalued. ... As an example, if share A is trading ... As an example, if share A is trading at $24 and the earnings per share for the most recent 12-month period is $3, then share A has a P/E ratio of $24/$3/year = 8 years. Put another way, the purchaser of the share is investing $8 for every dollar of annual earnings; or, if earnings stayed constant it would take 8 years to recoup the share price. Put another way, the purchaser of the share is investing $8 for every dollar of annual earnings; or, if earnings stayed constant it would take 8 years to recoup the share price. Companies with losses (negative earnings) or no profit have an undefined P/E ratio (usually shown as \"not applicable\" or \"N/A\"); sometimes, however, a negative P/E ratio may be shown. As the ratio of a stock (share price) to a flow (earnings per share), the P/E ratio has the units of time. It can be interpreted as the amount of time over which the company would need to sustain its current earnings in order to make enough money to pay back the current share price. It can be interpreted as the amount of time over which the company would need to sustain its current earnings in order to make enough money to pay back the current share price. While the P/E ratio can in principle be given in terms of any time unit, in practice it is essentially always implicitly reported in years, with the unit of \"years\" rarely indicated explicitly.",
"page_result": "\n\n\n\nPrice\u2013earnings ratio - Wikipedia\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\nJump to content\n
\nRobert Shiller's plot of the S&P composite real price\u2013earnings ratio and interest rates (1871\u20132012), from Irrational Exuberance, 2d ed.[1] In the preface to this edition, Shiller warns that \"the stock market has not come down to historical levels: the price\u2013earnings ratio as I define it in this book is still, at this writing [2005], in the mid-20s, far higher than the historical average. ... People still place too much confidence in the markets and have too strong a belief that paying attention to the gyrations in their investments will someday make them rich, and so they do not make conservative preparations for possible bad outcomes.\"\n
The price\u2013earnings ratio, also known as P/E ratio, P/E, or PER, is the ratio of a company's share (stock) price to the company's earnings per share. The ratio is used for valuing companies and to find out whether they are overvalued or undervalued. \n
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As an example, if share A is trading at $24 and the earnings per share for the most recent 12-month period is $3, then share A has a P/E ratio of $24/$3/year = 8 years. Put another way, the purchaser of the share is investing $8 for every dollar of annual earnings; or, if earnings stayed constant it would take 8 years to recoup the share price. Companies with losses (negative earnings) or no profit have an undefined P/E ratio (usually shown as \"not applicable\" or \"N/A\"); sometimes, however, a negative P/E ratio may be shown.\n
There are multiple versions of the P/E ratio, depending on whether earnings are projected or realized, and the type of earnings.\n
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\"Trailing P/E\" uses the weighted average share price of common shares in issue divided by the net income for the most recent 12-month period. This is the most common meaning of \"P/E\" if no other qualifier is specified. Monthly earnings data for individual companies are not available, and in any case usually fluctuate seasonally, so the previous four quarterly earnings reports are used and earnings per share are updated quarterly. Note, each company chooses its own financial year so the timing of updates varies from one to another.
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\"Trailing P/E from continued operations\" uses operating earnings, which exclude earnings from discontinued operations, extraordinary items (e.g. one-off windfalls and write-downs), and accounting changes.
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\"Forward P/E\": Instead of net income, this uses estimated net earnings over next 12 months. Estimates are typically derived as the mean of those published by a select group of analysts (selection criteria are rarely cited).
Variations on the standard trailing and forward P/E ratios are common. Generally, alternative P/E measures substitute different measures of earnings, such as rolling averages over longer periods of time (to attempt to \"smooth\" volatile or cyclical earnings, for example),[2] or \"corrected\" earnings figures that exclude certain extraordinary events or one-off gains or losses. The definitions may not be standardized. For companies that are loss-making, or whose earnings are expected to change dramatically, a \"primary\" P/E can be used instead, based on the earnings projections made for the next years to which a discount calculation is applied.\n
As the ratio of a stock (share price) to a flow (earnings per share), the P/E ratio has the units of time. It can be interpreted as the amount of time over which the company would need to sustain its current earnings in order to make enough money to pay back the current share price.[3] While the P/E ratio can in principle be given in terms of any time unit, in practice it is essentially always implicitly reported in years, with the unit of \"years\" rarely indicated explicitly. (This is the convention followed in this article.)[dubious – discuss]\n
The price/earnings ratio (PER) is the most widely used method for determining whether shares are \"correctly\" valued in relation to one another. But the PER does not in itself indicate whether the share is a bargain. The PER depends on the market's perception of the risk and future growth in earnings. A company with a low PER indicates that the market perceives it as higher risk or lower growth or both as compared to a company with a higher PER. The PER of a listed company's share is the result of the collective perception of the market as to how risky the company is and what its earnings growth prospects are in relation to that of other companies. Investors use the PER to compare their own perception of the risk and growth of a company against the market's collective perception of the risk and growth as reflected in the current PER. If investors believe that their perception is superior to that of the market, they can make the decision to buy or sell accordingly.[4]\n
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Historical P/E ratios for the U.S. stock market[edit]
\nPrice\u2013earnings ratios as a predictor of twenty-year returns based upon the plot by Robert Shiller (Figure 10.1,[1]source). The horizontal axis shows the real price\u2013earnings ratio of the S&P Composite Stock Price Index as computed in Irrational Exuberance (inflation adjusted price divided by the prior ten-year mean of inflation-adjusted earnings). The vertical axis shows the geometric average real annual return on investing in the S&P Composite Stock Price Index, reinvesting dividends, and selling twenty years later. Data from different twenty-year periods is color-coded as shown in the key. See also ten-year returns. Shiller stated in 2005 that this plot \"confirms that long-term investors\u2014investors who commit their money to an investment for ten full years\u2014did do well when prices were low relative to earnings at the beginning of the ten years. Long-term investors would be well advised, individually, to lower their exposure to the stock market when it is high, as it has been recently, and get into the market when it is low.\"[1]\n
Since 1900, the average P/E ratio for the S&P 500 index has ranged from 4.78 in Dec 1920 to 44.20 in Dec 1999.[5] However, except for some brief periods, during 1920\u20131990 the market P/E ratio was mostly between 10 and 20.[6]\n
The average P/E of the market varies in relation with, among other factors, expected growth of earnings, expected stability of earnings, expected inflation, and yields of competing investments. For example, when U.S. treasury bonds yield high returns, investors pay less for a given earnings per share and P/E's fall.[citation needed]\n
The average U.S. equity P/E ratio from 1900 to 2005 is 14 (or 16, depending on whether the geometric mean or the arithmetic mean, respectively, is used to average).[citation needed]\n
Jeremy Siegel has suggested that the average P/E ratio of about 15 [7] (or earnings yield of about 6.6%) arises due to the long-term returns for stocks of about 6.8%. In Stocks for the Long Run, (2002 edition) he had argued that with favorable developments like the lower capital gains tax rates and transaction costs, P/E ratio in \"low twenties\" is sustainable, despite being higher than the historic average.\n
Note that at the height of the Dot-com bubble P/E had risen to 32. The collapse in earnings caused P/E to rise to 46.50 in 2001. It has declined to a more sustainable region of 17. Its decline in recent years has been due to higher earnings growth.\n
Due to the collapse in earnings and rapid stock market recovery following the 2020 Coronavirus Crash, the trailing P/E ratio reached 38.3 on October 12, 2020. This elevated level was only attained twice in history, 2001-2002 and 2008-2009.[9]\n
The P/E ratio of a company is a major focus for many managers. They are usually paid in company stock or options on their company's stock (a form of payment that is supposed to align the interests of management with the interests of other stock holders). The stock price can increase in one of two ways: either through improved earnings or through an improved multiple that the market assigns to those earnings. In turn, the primary drivers for multiples such as the P/E ratio is through higher and more sustained earnings growth rates.\n
Consequently, managers have strong incentives to boost earnings per share, even in the short term, and/or improve long-term growth rates. This can influence business decisions in several ways:\n
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If a company wants to acquire companies with a higher P/E ratio than its own, it usually prefers paying in cash or debt rather than in stock. Though in theory the method of payment makes no difference to value, doing it this way offsets or avoids earnings dilution (see accretion/dilution analysis).
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Conversely, companies with higher P/E ratios than their targets are more tempted to use their stock to pay for acquisitions.
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Companies with high P/E ratios but volatile earnings may be tempted to find ways to smooth earnings and diversify risk\u2014this is the theory behind building conglomerates.
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Conversely, companies with low P/E ratios may be tempted to acquire small high-growth businesses in an effort to \"rebrand\" their portfolio of activities and burnish their image as growth stocks and thus obtain a higher PE rating.
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Companies try to smooth earnings, for example by \"slush fund accounting\" (hiding excess earnings in good years to cover for losses in lean years). Such measures are designed to create the image that the company always slowly but steadily increases profits, with the goal to increase the P/E ratio.
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Companies with low P/E ratios are usually more open to leveraging their balance sheet. As seen above, this mechanically lowers the P/E ratio, which means the company looks cheaper than it did before leverage, and also improves earnings growth rates. Both of these factors help drive up the share price.
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Strictly speaking, the ratio is measured in years, since the price is measured in dollars and earnings are measured in dollars per year. Therefore, the ratio demonstrates how many years it takes to cover the price, if earnings stay the same.
In general, a high price\u2013earning ratio indicates that investors are expecting higher growth of company's earnings in the future compared to companies with a lower price\u2013earning ratio.[10] A low price\u2013earning ratio may indicate either that a company may currently be undervalued or that the company is doing exceptionally well relative to its past trends. The price-to-earnings ratio can also be seen as a means of standardizing the value of one dollar of earnings throughout the stock market. In theory, by taking the median of P/E ratios over a period of several years, one could formulate something of a standardized P/E ratio, which could then be seen as a benchmark and used to indicate whether or not a stock is worth buying. In private equity, the extrapolation of past performance is driven by stale investments. State and local governments that are more fiscally stressed by higher unfunded pension liabilities assume higher portfolio returns through higher inflation assumptions, but this factor does not attenuate the extrapolative effects of past returns.[11]\n
When a company has no earnings or is posting losses, in both cases P/E will be expressed as \"N/A.\" Though it is possible to calculate a negative P/E, this is not the common convention.\n
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"page_last_modified": " Fri, 23 Feb 2024 03:48:21 GMT"
},
{
"page_name": "Price Earnings Ratio - Formula, Examples and Guide to P/E Ratio",
"page_url": "https://corporatefinanceinstitute.com/resources/valuation/price-earnings-ratio/",
"page_snippet": "The Price Earnings Ratio (P/E Ratio is the relationship between a company\u2019s stock price and earnings per share. It provides a better sense of the value of a company.The Price Earnings Ratio (P/E Ratio) is the relationship between a company\u2019s stock price and earnings per share (EPS). It is a popular ratio that gives investors a better sense of the value of the company. The P/E ratio shows the expectations of the market and is the price you must pay per unit of current earnings (or future earnings, as the case may be). Companies with a high Price Earnings Ratio are often considered to be growth stocks. This indicates a positive future performance, and investors have higher expectations for future earnings growth and are willing to pay more for them. Companies with a low Price Earnings Ratio are often considered to be value stocks. It means they are undervalued because their stock prices trade lower relative to their fundamentals. This mispricing will be a great bargain and will prompt investors to buy the stock before the market corrects it. The beauty of the P/E ratio is that it standardizes stocks of different prices and earnings levels. The P/E is also called an earnings multiple. There are two types of P/E: trailing and forward. The former is based on previous periods of earnings per share, while a leading or forward P/E ratio is when EPS calculations are based on future estimates, which predicted numbers (often provided by management or equity research analysts).",
"page_result": "\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\nPrice Earnings Ratio - Formula, Examples and Guide to P/E Ratio\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n
The Price Earnings Ratio (P/E Ratio) is the relationship between a company’s stock price and earnings per share (EPS). It is a popular ratio that gives investors a better sense of the value of the company. The P/E ratio shows the expectations of the market and is the price you must pay per unit of current earnings (or future earnings, as the case may be).
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Earnings are important when valuing a company’s stock because investors want to know how profitable a company is and how profitable it will be in the future. Furthermore, if the company doesn’t grow and the current level of earnings remains constant, the P/E can be interpreted as the number of years it will take for the company to pay back the amount paid for each share.
Looking at the P/E of a stock tells you very little about it if it’s not compared to the company’s historical P/E or the competitor’s P/E from the same industry. It’s not easy to conclude whether a stock with a P/E of 10x is a bargain or a P/E of 50x is expensive without performing any comparisons.
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The beauty of the P/E ratio is that it standardizes stocks of different prices and earnings levels.
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The P/E is also called an earnings multiple. There are two types of P/E: trailing and forward. The former is based on previous periods of earnings per share, while a leading or forward P/E ratio is when EPS calculations are based on future estimates, which predicted numbers (often provided by management or equity research analysts).
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Price Earnings Ratio Formula
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P/E = Stock Price Per Share / Earnings Per Share
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P/E = Market Capitalization / Total Net Earnings
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or
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Justified P/E = Dividend Payout Ratio / R – G
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where;
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R = Required Rate of Return
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G = Sustainable Growth Rate
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P/E Ratio Formula Explanation
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The basic P/E formula takes the current stock price and EPS to find the current P/E. EPS is found by taking earnings from the last twelve months divided by the weighted average shares outstanding. Earnings can be normalized for unusual or one-off items that can impact earnings abnormally. Learn more about normalized EPS.
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The justified P/E ratio is used to find the P/E ratio that an investor should be paying for, based on the companies dividend and retention policy, growth rate, and the investor’s required rate of return. Comparing justified P/E to basic P/E is a common stock valuation method.
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Why Use the Price Earnings Ratio?
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Investors want to buy financially sound companies that offer a good return on investment (ROI). Among the many ratios, the P/E is part of the research process for selecting stocks because we can figure out whether we are paying a fair price.
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Similar companies within the same industry are grouped together for comparison, regardless of the varying stock prices. Moreover, it’s quick and easy to use when we’re trying to value a company using earnings. When a high or a low P/E is found, we can quickly assess what kind of stock or company we are dealing with.
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High P/E
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Companies with a high Price Earnings Ratio are often considered to be growth stocks. This indicates a positive future performance, and investors have higher expectations for future earnings growth and are willing to pay more for them.
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The downside to this is that growth stocks are often higher in volatility, and this puts a lot of pressure on companies to do more to justify their higher valuation. For this reason, investing in growth stocks will more likely be seen as a risky investment. Stocks with high P/E ratios can also be considered overvalued.
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Low P/E
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Companies with a low Price Earnings Ratio are often considered to be value stocks. It means they are undervalued because their stock prices trade lower relative to their fundamentals. This mispricing will be a great bargain and will prompt investors to buy the stock before the market corrects it. And when it does, investors make a profit as a result of a higher stock price. Examples of low P/E stocks can be found in mature industries that pay a steady rate of dividends.
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P/E Ratio Example
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If Stock A is trading at $30 and Stock B at $20, Stock A is not necessarily more expensive. The P/E ratio can help us determine, from a valuation perspective, which of the two is cheaper.
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If the sector’s average P/E is 15, Stock A has a P/E = 15 and Stock B has a P/E = 30, stock A is cheaper despite having a higher absolute price than Stock B because you pay less for every $1 of current earnings. However, Stock B has a higher ratio than both its competitor and the sector. This might mean that investors will expect higher earnings growth in the future relative to the market.
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The P/E ratio is just one of the many valuation measures and financial analysis tools that we use to guide us in our investment decision, and it shouldn’t be the only one.
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P/E Ratio Template
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Download the free Excel template now to advance your finance knowledge!
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Video Explanation of the Price Earnings Ratio
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Below is a short video that explains how to calculate a company’s price-to-earnings ratio and how to interpret the results.
The justified P/E ratio above is calculated independently of the standard P/E. In other words, the two ratios should produce two different results. If the P/E is lower than the justified P/E ratio, the company is undervalued, and purchasing the stock will result in profits if the alpha is closed.
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Limitations of Price Earnings Ratio
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Finding the true value of a stock cannot just be calculated using current year earnings. The value depends on all expected future cash flows and earnings of a company. Price Earnings Ratio is used as a good starting point. It means little just by itself unless we have some understanding of the growth prospects in EPS and risk profile of the company. An investor must dig deeper into the company’s financial statements and use other valuation and financial analysis methods to get a better picture of a company’s value and performance.
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Additionally, the Price Earnings Ratio can produce wonky results, as demonstrated below. Negative EPS resulting from a loss in earnings will produce a negative P/E. An exceedingly high P/E can be generated by a company with close to zero net income, resulting in a very low EPS in the decimals.
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Additional Resources
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"page_name": "Price/Earnings Analysis Indicates Stock Market is Overvalued",
"page_url": "https://www.currentmarketvaluation.com/models/price-earnings.php",
"page_snippet": "The P/E ratio of the S&P500 shows that the market is currently 58.9% overvalued compared to historical norms.The current S&P500 10-year (CAPE) P/E Ratio is 32.2. This is 58.9% above the modern-era market average of 20.2, putting the current P/E 1.5 standard deviations above the modern-era average, indicating that the stock market is Overvalued. The P/E ratio is (as the name suggests), a ratio of a stock price divided by the firm's yearly earnings per share. The implied logic here is that a mature firm returns all profits to shareholders via dividends. The P/E then becomes a measure of how many years it will take the investor to earn back their principal from the initial investment. Imagine TechCo was founded 5 years ago, and their earnings per year (per share) have been $0, $1, $1.50, $2, and $5. Let's also assume that TechCo's current share price is $100, just like ACME in the prior example. Because the most recent earnings-per-share for TechCo is $5, that means TechCo's P/E ratio is $100/$5 = 20. Because the most recent earnings-per-share for TechCo is $5, that means TechCo's P/E ratio is $100/$5 = 20. The message here is that, at current earnings, investors in TechCo will theoretically get their money back after 20 years. This is twice as high as ACME -- but why? If it takes twice as long for TechCo to make profits as it does for ACME, why is their stock valued at the same price?",
"page_result": "\n\n\n\n\t\n\t\t\n\t\tUsing P/E Ratio to Determine Current US Stock Market Valuation\n\t\t\n\t\t\n\t\t\n\t\t\n\t\t\n\t\t\n\t\t\n\t\t\n\t\t\n\t\t\n\t\t\n\t\t\t\n\t\t\n\t\n\t\n\t\n\t\n\t\n\t\n\t\n\t\n\t\n\t\n\t\n\t\n\t \n\t\n\t\n\t\n\t\n\t\n\t\n\t\n\t\n\t\n\n\t\n\t\n\t\n\n\t\n\t\n\t\n\t\n\t\n\t\n\t\n\t\n\t\n\t\n\t\n\t\n\t\n\t\n\t\n\t\n\t\t\t\n\t\t\n\t\t\n\t\t\n\t\t\n\t\t\n\t\t\n\t\t\n\t\t\n\t\t\n\t\t\n\t\t2024-01-31\n\t\t\n\t\t\n\t\tJanuary 31, 2024\n\t\t2024 01 31\n\t\t20.2\n\t\t1.5\n\t\tabove\n\t\t#fd7e14\n\t\t32.2\n\t\t\n\t\n\t\n\t\n\t\n\t\n\t\t\t\t\n\t\t\n\n\t\n\t\n\t
\n\t\tAll models updated ~2 weeks after each month end. \n\t\t\n\t\tBecome a member for weekly model updates, and more.\n\t
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\n\t\t\t\tUpdated on January 31, 2024\n\t\t\t\t
Price/Earnings Ratio
\n\t\t\t\tsuggests that the US stock market is \n\t\t\t\t
The P/E ratio is a classic measure of a stock's value indicating how many years of profits (at the current earnings rate) it takes to recoup an investment in the stock. The current S&P500 10-year P/E Ratio is 32.2. This is 58.9% above the modern-era market average of 20.2, putting the current P/E 1.5 standard deviations above the modern-era average. This suggests that the market is Overvalued.
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Why Does it Matter?
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P/E ratios can only go so high. To justify a P/E ratio that is consistently above its own historic average for long periods of time, the US stock market must not only continue to grow, but would need to continue to grow at a continuously increasing rate.
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The below chart shows the historical trend of this ratio as well as its most current value. For more information on this model's methodology and our analysis, keep reading below.
Member Dashboard: Access a dashboard page summarizing each model and aggregate market value status.
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Correlations: Members can view detailed charts and metrics about the historical correlation that each valuation model has with subsequent S&P500 performance, over investment horizons from 1-month to 10-years.
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Downloads: Download up to 70 years historical data for every model in clean .xls format - use to better understand market cycles, or to inform your own market models.
P/E ratios are a cornerstone of fundamental stock valuation analysis, and are most commonly looked at for individual firms. The P/E ratio is (as the name suggests), a ratio of a stock price divided by the firm's yearly earnings per share. The implied logic here is that a mature firm returns all profits to shareholders via dividends. The P/E then becomes a measure of how many years it will take the investor to earn back their principal from the initial investment. For example, if you buy 1 share of ACME Co for $100, and ACME consistently makes profits of $10 per-share, per-year, then it follows that it would take the investor 10 years to earn back their original $100 investment.
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P/E is calculated using the last reported actual earnings of the company. Let's look at another example - one where we expect future earnings to grow. Imagine TechCo was founded 5 years ago, and their earnings per year (per share) have been $0, $1, $1.50, $2, and $5. Let's also assume that TechCo's current share price is $100, just like ACME in the prior example. Because the most recent earnings-per-share for TechCo is $5, that means TechCo's P/E ratio is $100/$5 = 20. The message here is that, at current earnings, investors in TechCo will theoretically get their money back after 20 years. This is twice as high as ACME -- but why? If it takes twice as long for TechCo to make profits as it does for ACME, why is their stock valued at the same price? The answer is obviously the growth rate of TechCo's profits. TechCo is a new company, and has been growing profits very quickly over the last 5 years, and so investors expect that trend to continue. This is why high growth companies tend to have very high P/Es - the market has very high expectations for their future results (relative to current results).
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The same analysis can be done to the entire stock market. By adding up the price of every share in the S&P500, and comparing that to the sum of all earnings-per-share generated by those companies, you can easily calculate the P/E ratio of the US stock market.
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Below are both the total S&P500 aggregate value, and aggregate earnings.
Here is the same chart again, but with a logarithmic axis to more clearly illustrate that the data do track each other somewhat evenly.
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Data
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The charts above show a clear relationship between price and earnings (particularly noticeable on the log chart). Just by eyeballing that chart you can see that both series have steadily risen over time, and that S&P500 price tends to stay (very roughly) 10x-20x larger than yearly earnings. By dividing price by earnings (the P/E ratio) we can see this relationship explicitly, below.
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P/E10 (CAPE)
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The chart above shows the standard calculation of the S&P500 PE ratio since 1950. Since this is a measurement of current price divided by most recent earnings, the calculation is subject to high volatility caused by peaks and troughs in the business cycle. For example, in mid-2008 at the nadir of the financial crisis S&P500 earnings across the board fell about 90% in about one year. Despite stock prices also going down significantly, this caused the market P/E at the time to spike over 120.
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For that reason, rather than use the current P/E, when doing long-term analysis it is more useful to use the Cyclically Adjusted Price Earnings (CAPE) ratio. This is very similar to the regular P/E, but rather than using the most recent earnings data, the CAPE ratio looks at current price divided by the average earnings over the prior 10 years. The CAPE ratio is shown below, and largely follows the same trend as the current PE ratio with a lot of the volatility smoothed out.
The chart below shows the exact same CAPE ratio data series as the prior chart - only the y-axis has changed to baseline 0 at the average CAPE ratio value of 20.2, and now shows horizontal bands representing standard deviations from that average. This presentation is in line with our other valuation models.
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Current Position
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As of January 31, 2024, the S&P500 P/E ratio is 58.9% (or 1.5 standard deviations) above its modern era average. By this valuation, the market is Overvalued (see our ratings guide for more information).
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And finally, let's look at how this data corresponds to S&P500 performance.
\n\t\t\t\t\t\t\tVisualizing Valuation Opportunities First, the main line shows the S&P500 since 1950, but color coded according to the standard deviation bands from our model. I.e., when the S&P500 was more than 1 standard deviation below its P/E average (such as in 1950, and again during the mid-70's to mid-80's) the chart is colored green, signifying undervaluation and a buying opportunity.
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Increasing Earnings Take note of the dotted line in the chart above. This shows the price level of the S&P500 if it were continuously valued at the modern-era P/E (CAPE) average of 19.8. That is, the dotted line is simply 20x the CAPE ratio. That dotted line is moving up faster than ever before, as corporate earnings have just exploded over the last 30 years driven by the tech boom.
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Criticisms of The Model
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No single model fully encompasses market valuation. Below are some key items to keep in mind regarding the PE10:
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Market Composition Changes
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The primary case against using historic PE as a valuation metric is the idea that PE ratios ought to be getting higher over time. Here is one cogent example of this argument. Changing market structures (e.g, heavier weight on high-growth tech stocks) have reasonably driven increased average CAPE ratios over time, as could/may have a multitude of other exogenous factors (e.g, recent Fed interest rate policies promoting low rates and high growth). As long as the economy/industry doesn't revert back to that of the 1960's, why should we expect market P/E ratios to?
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There is no arguing that the CAPE ratio has risen over time, and particularly since ~2000 when tech/growth stocks have becoming increasingly dominant in the S&P500. We agree that it doesn't make sense to compare today's market to the 1800's, and so this criticism is primarily why we do not use data prior to 1950 in this model. And while the average CAPE ratio has continued to increase steadily since 1950 as well, it's reasonable to ask what the 'natural' rate of increase here should be.
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Interest Rates
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Similar to the Buffett Indicator, the CAPE ratio does not take into account the current interest rate environment. Lower interest rates generally justify higher valuations because they reduce the cost of capital and increase the present value of future cash flows. Luckily, we examine and model the relationship between interest rates and stock prices in our Interest Rate Model.\n\t\t\t\t\t\t\t\n\t\t\t\t\t\t\t
Delayed Reflection of Current Profitability Trends
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The ten-year earnings average component in the CAPE ratio means it might not promptly capture the most recent profitability trends in rapidly evolving industries or fluctuating economic climates. This characteristic can limit its effectiveness as a real-time stock market valuation tool, particularly in industries that are heavily influenced by technological advancements and innovation.
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For example, if AI creates a productivity explosion in the next few years, short and mid term firm profits will rise sharply, but will not be fully reflected into the CAPE ratio for 10 years. This will cause the CAPE ratio to suggest that the market is highly overvalued, when in fact it may not be. For investors seeking up-to-date insights, it's important to consider additional metrics and market indicators that react more quickly to present changes in profitability.
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\n\t![real price\u2013earnings ratio of the S&P Composite Stock Price Index](\"/wiki/File:IE_Real_SandP_Price-Earnings_Ratio,_Interest_1871-2006.png\"){kind=link}
![ten-year returns](\"/wiki/File:Price-Earnings_Ratios_as_a_Predictor_of_Ten-Year_Returns_(Shiller_Data).png\"){kind=link}