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Do P/E’s matter?

Posted By Mike On Sep 3, 2009 @ 2:42 pm In Long term view, charts | 23 Comments

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Source: Irrational Exuberance, Robert Shiller, 2000

The average 12 month earnings for the S&P 500 from June 2000 to June 2009 (10 years) is $49.84.  The index earned $14.88 in 2008 and $7.62 in the 12 months through June 30, 2009. The respective PE’s at a value of 1000 are roughly 20, 65 and 130.

Assuming earnings soon rise to $50 and are sustained, a tall order in my opinion, the expected 20-year annualized return on the S&P would still only be about 1%. Is that enough to justify the risk that earnings do not recover? Shiller’s method of smoothing earnings over 10 years makes good sense, but what if that 10 years encompassed the greatest credit bubble in history, and it has now been popped? What is the expected return then? To look at it another way, I would say that your expected return on T-bills is very, very high in terms of stock.

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