The Average P/E for the S&P 500 Index and How to Analyze It
The price-earnings ratio, also known simply as the “P/E,” of the S&P 500 Index, can be used as a general barometer for determining whether stocks or stock mutual funds are fairly priced. For example, an above-average P/E on the S&P 500 may indicate that stocks in general are overpriced and thus near a decline. If the P/E on the S&P 500 is below its historical mean, it may indicate a good time to buy stocks or stock mutual funds. For reference, the average P/E ratio for stocks since the 1870s has been about 16.8. If you take the average price of the large-cap stocks in the S&P 500 Index and divide that collective price by the respective mean earnings, you get the P/E for what investors call “the market.” If this P/E is significantly higher than historical mean of 16.8, it’s reasonable to expect stock prices to fall at some point. If the P/E is lower than the historical mean, you may expect prices to rise.
Debunking the P/E: Why It Can Be a Deceptive Indicator
Valuations for stocks can swing far away from the 16.8 P/E average. In fact, the P/E often lags economic reality. For example, according to advisorperspectives.com, “In 1999, a few months before the top of the Tech Bubble, the conventional P/E ratio hit 34. It peaked close to 47 two years after the market topped out.” The P/E is a ratio (price divided by earnings). Therefore, if the earnings (the denominator) fall more quickly than prices (the numerator), the P/E can be deceptively high and thus make the P/E inconsistent or perhaps a lagging indicator. A P/E above 16.8 on the S&P 500 Index does not indicate a sell signal, nor does a P/E below that historical average indicate a sell signal. However, a prudent investor can use the S&P’s P/E as one of many measures of health for the stock market. The conventional P/E looks back at the trailing twelve months, or “TTM,” and we know that the past is not a guarantee of future performance.
P/E Ratio and Fundamental Analysis
From a fundamental analysis perspective, stock prices are a reflection of expectations, but they also reflect the demand for equities as assets. For example, in the early 2010s, bond yields were falling, and US Treasury Bonds were paying near-zero interest. Investors who were looking for income began buying dividend-paying stocks and dividend mutual funds. The distance in time from the extremes of the 2008 market decline steadily gave investors confidence to re-enter stocks, even as prices on indexes, such as the Dow Jones Industrial Average, reached record levels in early 2013, when the S&P 500 P/E was still at the historical average of 15.00. Stock prices continued climbing in 2014, and by the end of 2015 the S&P 500 P/E was nearly 21.00. By late 2019, stocks were still in the longest bull market in history, and the S&P 500 P/E remained around 22.00. Disclaimer: The information on this site is provided for discussion purposes only and should not be misconstrued as investment advice. Under no circumstances does this information represent a recommendation to buy or sell securities.
