Time Frame: Long
Category: Fundamental

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: Magnitude
Updated: Weekly (as of Friday close)

Strategy