Chart of the Day 02/25/2011
S&P 500 PE Ratio

Today's chart of the day displays the PE Ratio of the S&P 500 going back in time to the year 1900.

As you'll read in the commentary from the chart provider below, stocks are currently inexpensive generally speaking. I emphasize generally speaking and you'll see why...

I took a look at stock prices from 1970 to 1980 for a comparison to see how inexpensive stocks really are.

In January 1973 the S&P 500 was at 119 when the PE Ratio was approx. 20 on the chart below. Historically and prior to more recent times, a PE Ratio near 20 was Expensive for the S&P 500. With the S&P 500 at 119 in 1973, this proved to be the case.

119 proved to be a market top at the time and prices declined to the low 60's towards the latter part of 1974, less than 2 years later. When the S&P 500 reached the low 60's in 1974, the PE Ratio declined as well, to approx. 7.

Looking at the long term data on the PE Ratio chart below, a PE Ratio below 10 has proved to be a good time to buy stocks in which they were indeed inexpensive at that level, not near 20.

Who knows for sure whether the PE Ratio will get down below 10 again, but if it does, based on history, then we'll be able to say that stocks are indeed inexpensive.

Today's chart illustrates how the recent rise in earnings has impacted the current valuation of the stock market as measured by the price to earnings ratio (PE ratio).

Generally speaking, when the PE ratio is high, stocks are considered to be expensive. When the PE ratio is low, stocks are considered to be inexpensive.

From 1900 into the mid-1990s, the PE ratio tended to peak in the low to mid-20s (red line) and trough somewhere around seven (green line). Notice how investors were willing to pay much more for one dollar of earnings during the dot-com boom, the dot-com bust and financial crisis.

Currently, with 94% of US corporations having reported for Q4 2010, the PE ratio stands at 17 which is a relatively low level when compared to the past two decades.

Chart courtesy of Chart of the Day
Chart of the Day 02/25/2011 - S&P 500 PE Ratio



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