The below portion of the article & chart are what stimulated my thinking about P/Es. They are from the WJS, 3/10/08, C1 article, "Are Low P/Es a Valid Reason to Buy Stocks":
"...Some argue stocks are attractively priced after a 17% decline in the Standard & Poor's 500-stock index since October. Based on earnings forecasts for 2008 collected by Reuters Estimates, the S&P 500 is trading at 13.2 times projected earnings, compared with an average of 16.5 times going back to 1989, according to data compiled by Morgan Stanley.
Price-to-earnings ratios reflect the amount investors are willing to pay for future earnings. When these ratios fall below long-term trends, conventional wisdom is that stocks are cheap and it is time to buy.
Until 2000, investors feasted on the combination of rising P/E ratios and rising stock prices. At the end of the 1980-82 bear market, S&P stocks changed hands at a price-to-earnings ratio of 8.7, according to Morgan Stanley's data. In the next 17 years, the ratio moved higher, topping out just shy of 30 in the spring of 1999. During that time, when the S&P rose an average of about 17% a year, roughly one-third of returns on the S&P 500 were the result of rising P/E multiples, according to Ibbotson Associates...."
While I'm not suggesting that P/Es will revert back to the 7-8 range of the '70s, I continue to be concerned that a 2009-2010 double-dip slowdown, stagflation, inflation, credit squeeze... or whatever the current buzz-word is... could continue the trend of falling P/Es.
For those wishing to look further into the subject of P/E ratios over time look at www.crestmontresearch.com, which holds a "treasure trove" of data on the subject.
In essence they agree that growth & quality are key to finding worthwhile stocks... fortunately for SC, BI, etc... and us. However, they believe that valuation (P/E) could be more, equal or less important depending on the trend in the marketplace.
I suggest that looking at their website is worth some time... particularly, if we are moving into inflationary times when P/E ratios move inversly to inflation. Even if you think their reseach is not valid, it's worth some time to gain historic perspective.
Below is a recap. In particular, check out the links under numbers One & Six. Also, page down to the link under "The Truth About P/Es. And finally, the article "Natural Pinnical to P/Es". found by clicking on the home page "Stock Market" button and paging down.
Steve Phillips
_________________________________________________________________
Copyright 2003-2008, Crestmont Research (www.CrestmontResearch.com)
Executive Summary:
CRESTMONT'S RESEARCH: PUTTING IT TOGETHER
January 31, 2008
1. Average Rarely Happens: returns from the stock market over decade-long
periods have rarely averaged the historical 10%; it has most often been well above
average or well below average. There is no single factor that has as much impact
on the variability of total returns from the stock market over decade-long periods
as the change in the level of valuation (P/E ratios).
http://www.crestmontresearch.com/pdfs/Stock%20Rolling%20Components.pdf
2. The financial markets are much more volatile than most investors realize. The
past 20 years have only presented upside (positive) volatility. The bond and stock
markets were in secular bull market trends.
3. In the past 100 years, the annual change in stocks--half of the time--is more
than 16%, either up or down.
http://www.crestmontresearch.com/pdfs/Stock%20Dispersion.pdf
4. In the past 40 years (since interest rates began responding to inflation), over
every six-month period, rates change more than 50 bps almost 99% of the time
and more than 1% (100 bps) almost 80% of the time.
http://www.crestmontresearch.com/pdfs/i%20rate%206%20mo%20changes.pdf
5. Yet when P/E ratios are trending upward, the volatility is almost always on the
upside. When P/E's are trending down from historically high levels (like we're
seeing today), the volatility is more often on the downside.
6. Most investors are surprised to find out that real growth in the economy and
earnings per share grew at virtually the same rate from (1) the mid 1960's thru the
early 1980's as it did from (2) the early 1980's through 1999--yet the stock market
was flat in the first period and soared 10 times in the later period.
http://www.crestmontresearch.com/pdfs/Financial%20Physics%20Presentation.pdf
7. Why does this occur and what can be expected? Financial Physics explains it.
Financial Physics is the combination of well respected principles of economics and
recognized principles of finance.
8. The economy has grown at a fairly constant rate of averaging just above 3%
over the past century, and almost exactly 3% during each of the past 3 decades.
Earnings of public companies grow at a rate just below the economy (due to new
start-ups, entrepreneurial companies, etc.).
9. So the major driver to stock market returns above or below economic growth is
due to the trend in P/E ratios. The trend in P/E's is driven by the trend in inflation.
If inflation is headed away from price stability (near 1%), P/E's fall; if inflation is
headed toward 1%, P/E's rise.
http://www.crestmontresearch.com/pdfs/Stock%20Secular%20Chart.pdf
10. The dilemma today is that we're at low inflation and historically high P/E's; so
there's little room for rising P/Es. We're in the early stages of what historically has
presented itself as a secular bear market.
11. In secular bear markets (which are generally non-directional and highly volatile
market conditions), there are a number of strategies that are required. Crestmont
refers to it as "Row, Not Sail"...it requires actions rather than buy and hold.
12. These actions include more active investment management, more frequent
rebalancing, option writing, higher yielding securities, hedge funds, and other
active process strategies.
http://www.crestmontresearch.com/pdfs/Stocks%20Rebalancing.pdf
http://www.crestmontresearch.com/pdfs/HF%20Industry%20Presentation.pdf
13. It's a good time for investors to step back from such a "micro, market timing
focus", and to develop a business plan for investing that considers the expected
market environment and incorporates timeless strategies for wealth development
and wealth preservation.
14. For more information and descriptions about Crestmont's research, please
see:
Unexpected Returns: Understanding Secular Stock Market Cycles
www.UnexpectedReturns.com
Waiting For Average
http://www.crestmontresearch.com/pdfs/Stock%20Waiting%20For%20Avg.pdf
Portfolio Mismanagement
http://www.crestmontresearch.com/pdfs/Article%20Mismanagement.pdf
Markowitz Misunderstood
http://www.crestmontresearch.com/pdfs/Article%20Markowitz.pdf
The Truth About P/Es
http://www.crestmontresearch.com/pdfs/Stock%20Truth%20PEs.pdf
Beyond The Horizon
http://www.crestmontresearch.com/pdfs/Stock%20Beyond%20Horizon.pdf
Destitute At 80: Retiring In Secular Cycles
http://www.crestmontresearch.com/pdfs/Stock%20Retirement%20SWR.pdf