Tuesday, June 07, 2011

P/E Ratios - What They Tells Us of Probable Returns

Given our high P/E ratios here in the US, I'm pulling up an old chart that needs to be revisited. Comes from Dr. Robert Shiller and it is a very insightful chart. However, methinks it may be high time to see if the loyal readers and lieutenants of the Captain are starting to understand to become economists in their own right and can deduce the lessons that need to be learned from it.

So, do you see what I see?


Anonymous said...

Not an economist or statician, nor even inspired to become either, but it looks to me that there is a inverse correlation between P/E and earnings - e.g. the lower the PE the higher the returns, and vice versa. So average PE over a 10 year period is a reasonable predictor of the return of the market.

The second observation is that it doesn't matter which of the date ranges selected - there's a correlation in all the shown periods.

The third observation is that the current situation is no different than any of the other periods of time.

Last, it appears the averaging involved in the chart tends to dampen any short term blips of irrational exuberance and insanity of the market.

Bike Bubba said...

Whoa--it's like "profitability" is a key factor in determining whether a company will grow to merit a higher stock valuation. And it's also like the 7-10% annual returns after inflation that we're always being promised by the financial guys are a chimera.

Whoa, man, that's some good stuff...

Jaime Roberto said...

The higher the P/E, the lower the return. So don't chase stocks with high P/E ratios.

Anonymous said...

...You included all the companies that had low P/E ratios because they were on the verge of bankruptcy, right? And the fact that treasuries had comparable long-term yields pre-2000, and the fact that investors are willing to take lower returns on investments in mature economies, implying a higher evaluation.

Yeah, that's what I thought.