Monday, February 23, 2009

Dr. Robert Shiller Finally Updates His P/E Data

Robert Shiller, as some of you know, is arguably one of the finest economic minds in the US. Which is of course why he isn't in Obama's cabinet.

Regardless, he has hands down the best economic data regarding a very important measure, the Price to Earnings Ratio.

Now I've mentioned this ratio before as to how it is used to gauge whether a stock is over or undervalued. By comparing the price of a stock to it's earnings you compare essentially what you pay versus what you get. The resulting ratio the Price to Earnings Ratio or "P/E" ratio essentially shows you what you pay in stock price for one dollar in earnings.

Historically the average stock represented by the S&P 500 has traded around a P/E of 15, denoted by the horizontal blue line. And though the stock market has taken a 25 year hiatus from sane and rational valuations due to dotcom bubbles, housing bubbles, oh and that whole thing where the Baby Boomers were told to invest their money in the stock market for retirement, it has finally returned to a more sane P/E of 13 (as Dr. Shiller FINALLY updated
this somewhat vital statistic on his web site);

Now a lot of people would say, "wow, gee whiz, now is the time to buy! We're finally below 15" but hold on there little buckaroos. There's just one little catch.

The "E" in the P/E ratio is earnings. Earnings from the previous 12 months. In other words, the past. The problem is the past is not what concerns people or drives stock prices. It's the future, and right now the future looks bleak. Sure earnings were alright for 2008, but 2009 they look to be horrible. And while the P/E ratio may be lower now, if earnings drop, then "E", the denominator of the P/E ratio will also drop, driving up the P/E ratio, meaning you're still paying too much P for what is going to be a dwindling or not existent E. Long story short, you could easily see a Dow Jones of about 5,000.

But don't worry about it, I hear Obama will save us.


Anonymous said...


Anonymous said...

Given that "E" hit $90 back in October 07 and the S&P hit 1562 on october 10, the bull multiple at its peak was about 17. Many predictions of 09 "E" come in optomistically at $60. If this number holds and the multiple drops to 12, we are fairly valued. However, should predicted "E" fall to 50 and the multiple drops to say 9, we are staring a further drop of at least 35%. This will be in line with the experience incurred in 1929 - 32. The real problem is that there is no where to run and no where to hide. Bond yeilds suck. Cash declines because of inflation and taxes. Stocks are cratering, house prices have no bottom and govenments have no solutions. If excess spending got you into this mess more spending will not get you out.

Anonymous said...

How about price to dividends?

Ginz88 said...

Looking at dividend yields, this thing is still overvalued. Past bear market bottoms finish with P/E's at around 8 and div yields far north of where they are now. We could be possibly see another 40% drop. That being said, fundamentals are horrible timing mechanisms. Who knows how long this will take with every gov't in the world trying to reflate this thing.

Anonymous said...

Let me know when it gets to five again amnd I'll start buying.

Anonymous said...

A little on the unrelated side but I'd like Captain's comment on this:
Wouldn't we all be better off if instead of TARP, feds had said U.S. government is guaranteeing all losses to financial institutions in the event of a default where the terms are renegotiated based on principal amount and interest rate. At the same time, they could have turned to property owners and said 'if you default, you will get workable new terms but Uncle Sam will go on the deed with you as co-owner and when the property is sold in the future, the homeowner will be subordinated to the government's interest in the amount of the shortfall feds had to pay in redoing the loan.
Wouldn't this have greatly aleviated the underlying causes of the credit crisis while keeping the eventual cost to the taxpayer down? Under Obama's envisioned plan, we are all incentivized to default on our loans and the eventual cost will be much higher.

Mitch said...

The P/E is still too high if you project future earnings, and then adjust for future long-term interest rates (up a LOT) and long term corporate tax rates (up a lot). S&P should be high single digits/low double digits based on this.

Anonymous said...

Where on Shiller's site did your data come from? Sorry, I looked but couldn't find.

Pooplips said...

I'm looking through your old posts. Is there a point where you were calling for people to buy the index?