The price-to-earnings or P/E ratio is a measure of the price paid for a share of stock relative to the annual profit earned per share by a business. The ratio has units of years, that is, it indicates how many years of earnings or stock dividends it takes to pay back the purchase price. The historical average for the stock market over the last 130 years was a little over 12, although some argue that it should be a wee bit higher than that. The S&P index, a collection of 500 stock-issuing companies that is much more representative of the overall economy than the 30 companies comprising the Dow-Jones average, was around 15 in 1990. By the end of the century it was at 30, and then peaked at 47 when the dotcom bubble burst, at a value four times greater than its historical average. The P/E ratio gradually decreased after the crash to a low of just over 17 at the end of 2006. As of Oct 7, 2009 the S&P P/E Ratio is 140.82, or three times higher than its value during the dotcom bubble crash.
Thanks for cheering me up.
What if the earnings are exactly zero? How o they calculate the P/Eration then?
Given the flexible and arcane - i.e. crookeder than a mesquite tree with advanced arthritis - nature of the accounting procedures, I’m sure that even dividing by zero is not beyond the talents of those who might be mathematicians if crime weren’t so ludicrously lucrative.
I wouldn’t worry about the 140. P/E is always high in a downturn. Companies with tangible assets (I think there still are some) higher than debt cannot sink far enough to maintain a low P/E. For example, Boeing might get order cancellations to the point that it makes no money at all, but because of the value of the plants, inventory, and expertise the company is still worth something. So the P/E approaches infinity.
What’s worrying many is that even after we get back to a “normal” economy, some companies will be unable to earn the amount they nominally earned in 2007, or even close to it. So in summary a present P/E of 140 is no worry, but an estimated 2011 P/E of 30 (1) even if stock prices don’t rise, is worrying.
(1) Figure made up, please consult a qualified investment adviser before believing. Inexpensive adviser services can be found at the Federal prison service - www.wegotfinancialcons.gov