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When evaluating securities
on their individual merits, it is particularly worthwhile to take into
account the comparison between stocks and bonds.
As a general rule both asset categories represent side by side an
alternative for a possible investment. Both markets are closely linked
together as investors are able to choose between the two. By comparing
the earnings yield of shares with the long-term yields of government
stocks, it is possible to make an estimation of whether or not the
stock market is fairly valued.
Benjamin Graham and David Dodd attributed particular significance to
the price-earnings ratio (the reciprocal of earnings yield) in the
first Security Analysis publication in 1934. Graham was of the opinion
that investors should avoid, where possible, companies with a high P/E
ratio as they deliver statistically long-term lower returns when
compared with shares with a lower P/E ratio.
The most comprehensive empirical study to date was conducted by
Professor of Economics, Robert J. Shiller (Irrational Exuberance)
covering the period from 1871 to 2003, in which he provides evidence
for the correlation between actual P/E ratio and the long-term
achievable market rate of return with S&P 500.
In accordance with Benjamin Graham’s recommendation to use average
values, Shiller used the inflation-adjusted average for the past 10
years, when working out the index return.
The most important
findings of the study
- The market P/E ratio normally shifts between a value
of 10 and 20.
- High P/E ratios continually lead to low or negative
returns and vice versa.
- From a P/E ratio of 25 upwards the risk of
significant market slumps increases in the following years.
The current P/E ratio of the S&P 500
The market P/E ratio of the
S&P 500, last determined in January 2006, is published on the
following pages. At Valueinvesting.de an account according to James P.
O’Shaughnessy (What Works On Wall Street) is used, which uses computer
analysed data from over 50 years to show that the combination of
specific key data when choosing shares, leads to long-term success.
The following analysis weights the P/E ratio, price to cash flow ratio,
price to net book value ratio and the profit margin percentage all
equally, whilst 25% more weight is given to the price to sales
relationship. Individual specific values are ordered by rank and added
to their respective weights. The result is a rank sum, by which the
list is ordered.
The business profits used in the list refer to the actual achieved
results within the last four quarters. The dividend returns are made up
of the most recently published, as well as the year’s projected,
quarterly dividends.
All other data is based upon the company’s published figures from its
most recently available business report. -- List
of the
S&P 500 enterprises [HTML-File]
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