Wednesday, February 04, 2009

S&P 500 Fair Value: 450

If there is such a thing as a "fair value" for the S&P 500 index, it's a price-to-earnings ratio (P/E) of 15 using "as reported" earnings. Typically this ratio varies between 10 and 20, with rare excursions outside of that range.

For the past few months, reported corporate earnings have been falling so quickly that the P/E ratio of the S&P 500 now stands at 28, which is almost as over-valued as it was during the bubble of 2000. To reach a P/E of 15, stocks would have to fall 46% from here, which corresponds to an S&P index level of 450.

Have a nice day!

8 comments:

RO said...

Hi, allthough you are 100% in GRZZX now, would you still hint to your readers who are not 100% allocated on new "buy" opportunities? (The S&P is close to 850 right now again)

Or..I just saw this new post, so I guess everything above 500 is buy ;)

Jody said...

Unfortunately I can't do that. I deliberately write about what I'm doing so that I'm not liable to others in case of a "buy" or "short" signal that leads to disaster.

Anonymous said...

Jody,

I am very interested in knowing where your source is for S&P 500 PE of 28 as of now.

Thanks.

Gary

Jody said...

Here.

Tim said...

Couldn't this be partially solved by a re-juggling (adding new ones removing those such as banks) companies within the S&P 500? For example remove GM and/or Ford and add Toyota.

Jody said...

The S&P 500 is a market-capitalization weighted index of domestic stocks, meaning that when companies like GM and Bank of America plummet in price, their importance in the index automatically diminishes. (Today they are ranked 445 and 51, respectively.) There's no need to replace them with anybody. Any company which falls far enough to fall out of the top 500 largest will probably be removed anyways.

You're probably thinking of the Dow Jones Industrial Average (Dow 30), which tends to be more arbitrary in how it adds, removes, and weights companies.

Anonymous said...

Jody,
Thanks for your data.

Is there a reason for you to compute SP500 PE based on reported earning (vs. operating earning)?

If operating earning is used for computation, SP500 PE will go down to 15.4 (according to your data).

Gary

Jody said...

Operating earnings are always overly-optimistic because they don't include one-time losses that a company doesn't consider to be part of its normal operating budget. Right now, banks which have lost billions of dollars in defaulted loans are not necessarily subtracting them from the "operating" column. Future projections of these optimistic earnings assume that the entire budget will go right back to what it was before the losses, but that's not at all guaranteed to be the case.

As-reported earnings, on the other hand, don't hide anything. Every blemish in the budget has to be included, and right now there are some really big blemishes out there.