Most Popular ArticlesSeptember 1, 2009
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It becomes clearer every day that the stock market does not follow a random walk and that there may be some predictability in long-term returns. But there's little agreement on how best to make such predictions. In this article, I'll take a look at using price/earnings ratios to predict future stock market performance.
In the late 1990's, Yale professor Robert Shiller used P/E's to warn about the overvalued stock market. His concerns were based on a method of measuring price/earnings ratios he had been working with since the early 1980's. The method goes back to work by Graham and Dodd and measures the price of a broad stock market measure, like the S&P 500, in relation to the past 10 years of average earnings. The reason for using 10 years is to smooth out (or “normalize”) the effects of business cycles. Shiller also adjusts his measures for inflation by translating both prices and earnings into consistent "real" numbers before doing the ratio calculations. You can access the Shiller data here.
When we look at the past 15 years (referring to Table 1 below), it is worth paying particular attention to two time periods.
Table 1 - Recent History of Annual Shiller P/E's
| Beginning of Year | Shiller P/E |
| 1994 | 21.5 |
| 1995 | 20.0 |
| 1996 | 24.3 |
| 1997 | 27.5 |
| 1998 | 32.3 |
| 1999 | 40.4 |
| 2000 | 42.5 |
| 2001 | 36.0 |
| 2002 | 30.1 |
| 2003 | 22.9 |
| 2004 | 25.7 |
| 2005 | 26.5 |
| 2006 | 25.4 |
| 2007 | 26.3 |
| 2008 | 24.0 |
| 2009 | 15.3 |
| Average 1928-2009 | 17.4 |
| High 1928-2009 (2000) | 42.5 |
| Low 1928-2009 (1982) | 7.4 |
| Current Value (8/18/09) | 17.7 |
Data Source: Shiller Data Base
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