S&P 500 Price/Earning Ratios

Description

The most basic measure of stock market value is price relative to the latest 12 months' earnings - the P/E ratio. In bear markets, investors terrified by bad news can drive the S&P 500 P/E ratio to under 10. In the 1974 bear market, this ratio dropped to 8 with many securities trading with even lower multiples. In bull markets, extreme optimism can drive the market's P/E to 25. In the 1995 bull market, many technology stocks were valued at over 50 times their prior 12 months' earnings, while the ratio for the S&P 500 fluctuated between 16 and 20.

Calculation & Significant Levels

S&P 500 Price/Earnings Ratio: Calculated by dividing the earnings over the latest 12 months' of the S&P 500 Index into the cash price of the index. A market P/E of 18 or higher is usually considered a sign of overvaluation. When the S&P 500 P/E drops below 10 the market is historically undervalued.

Formula: (S&P 500 cash index price)
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(S&P 500 index prior 12 months' earnings)

Gauge Elements: MagnitudeUpdated: Weekly (as of Friday close)

Strategy

It is important to consider where the economy is in the business cycle before interpreting the market's P/E. Bull markets are often born out of recessions when earnings are depressed. Therefore, in the early stages of a bull market this ratio can exceed 18 as investors anticipate increasing earnings. However, a market P/E over 18 in the later stages of an economic expansion is a warning of overvaluation. When this ratio dropped below 12, the long term investor has found good buying opportunities.