Wade Pfau on High CAPE ratios

[Lsbcal]

I don't recall whether profits were terrible in 2007/2008/2009. If they were, will PE10 fall dramatically once those bad profit years stop being counted in a few years?

This is a good question. I've been keeping a chart that uses the Schiller excel data to show some of the underlying variables.

In particular the standard deviation of the 10 year earnings has been rising since the 1990's. The PE1 over recent years would indicate where PE10 will wind up if earnings stay around where they are now. In short, if the real earnings hold up over the next 5 years, we should be closer to more normal PE10's.

In January 2015 the numbers were PE15=30.6, PE10=26.5, PE5=23.4, PE1=20.0.

.

 

[Totoro]

Just counterpoint (yeah I know) -- aren't the earnings of 2015 in % terms (profit margin of companies) at record highs now?

 

[Lsbcal]

Just counterpoint (yeah I know) -- aren't the earnings of 2015 in % terms (profit margin of companies) at record highs now?

Looking at Schiller's data, from Jan 2010 to now the real growth of the SP500 (price appreciation) has been 11.6% per year. Meanwhile the real growth in earnings was 10.5% per year. Then we should add in the dividends which were maybe 2% per year. Pretty nice.

I did a "what if" using the Schiller data to determine a final PE10 out in the future. Suppose the SP500 went up at 7% per year, and the earnings went up at 6% per year from now. It turns out that the PE10 would be about 26.8 in January 2020. So we could have a total return of maybe 7% + 2% dividends = 9% per year and the PE10 could stay about where it is now.

If the SP500 just went up 3% per year and the earnings just 2% per year, the Jan 2020 PE10=23.6 .

 

[Totoro]

I'm not so much concerned about growth in profit as I am in very high profit margins (profit as % of revenue) -- that seems to be at record highs (don't have the numbers on hand) and if so may be unsustainable?

As in, total S&P 500 earnings may drop 20% or more.

 

[Lsbcal]

So far the market doesn't see this happening. Always a possibility of low probability events coming true.

 

[HFWR]

i've never been totally convinced that the stock market is a leading indicator...

 

[dallas27]

I'm not so much concerned about growth in profit as I am in very high profit margins (profit as % of revenue) -- that seems to be at record highs (don't have the numbers on hand) and if so may be unsustainable?

As in, total S&P 500 earnings may drop 20% or more.

Margins will only drop once companies start trying to grow quickly to maintain market share, meaning the economy is getting awesome again. They will get big and fat, then the cycle will turn, they layoff everyone to get small and lean again to boost those margins. That's the cycle.


Sent from my iPhone using Early Retirement Forum