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Stingy Investor Tip Sheet

Peak Earnings

I've been looking at several stocks trading at very low price-to-peak-earnings ratios. That got me thinking. What does a price-to-peak-earnings-ratio graph look like for the S&P500?

Thanks to data from Robert Shiller, it's easy to make the graph which is shown below. The graph uses inflation adjusted data to remove the impact of, wait for it, inflation which could become a large factor when earnings remain below peak levels for a long time.

There are two lines shown in the graph. The blue line tracks the price-to-peak-earnings ratio and the green line shows the median price-to-peak-earnings ratio of 11.3. You can see that we are now below median levels on this measure.

(click for larger version)

I was interested to notice a very long period of real earnings weakness. Real earnings peaked near the start of 1917 and then declined. A new peak was only achieved in 1955. The long period of decline tends to reduce the appearance of the 1929 bubble. It also magnifies the subsequent downturn in the price-to-peak-earnings ratio.

Here's a graphical look at the S&P500's inflation-adjusted earnings history. The blue line shows earnings and the green line shows peak earnings.

(click for larger version)

As with other P/E graphs, we are currently below median levels which indicates that stocks are roughly fairly valued. But we aren't near historic lows either which indicates that stocks could fall further.

02/20/2009   11:35 AM EST   Permlink   save & shareMarkets

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