The Bottom Line
- The return of significant price downdrafts in stocks this year has flustered investors who grew accustomed to the relative calm of the previous two years.
- But market-watchers who take a longer view are focusing more on the bigger picture: whether today’s stock prices represent good value relative to their longer-term potential.
- Forward P/E ratios, which tie the estimated earnings of companies in future years to today’s prices, are one way to measure that.
- Applying that measure to the S&P 500 suggests that current worries may be misplaced; the market is by no means expensive compared to its recent past, as well as the past five years.
- One reason: the market hasn’t seen big gains since the end of 2017– in fact, the S&P 500 was down some 1% in total return terms1 as of April 3.
- But the other reason has a more potentially positive flavor – based on this quarter’s above-expected earnings season to date, estimates for future earnings have moved up enough to drive the forward P/E down from its December high of 20.1 to 16.6 – well below the 5-year average.
- Bottom line: in aggregate, by this specific measure, stocks represent good value at this point of the market. Which, of course, is no guarantee that they will either rise or fall from here. But the solidly lower P/E suggests that there could be even more attractive values to be found in the equity markets by active investors driven by fundamentals.
1 Source: Bloomberg, May 3.2018
The S&P 500 Index is an unmanaged index of 500 stocks that is generally representative of the performance of larger companies in the U.S. Indexes are unmanaged, and not available for direct investment. Index returns do not include fees or sales charges.
The price-earnings (P/E) ratio is a stock's (or index’s) price divided by its earnings per share (or index earnings). The forward P/E ratio is a stock’s (or index’s) current price divided by its estimated earnings per share (or estimated index earnings), usually one-year ahead.