S&P 500 Price-Earnings suggest time to buy

The forward Price-Earnings (PE) Ratio for the S&P 500, depicted by the blue line on the chart below, recently dipped below 20. In 2014 to 2105, PEs above 20 warned that stocks were overpriced.

We can see from the green and orange bars on the chart that the primary reason for the dip in forward PE is more optimistic earnings forecasts for 2017.

S&P500 Earnings Per Share and Forward PE Ratio

We can also see, from an examination of the past history, that each time forward PE dipped below 20 it was an opportune time to buy.

History also shows that each time the forward PE crossed to above 20 it was an opportune time to stop buying. Not necessarily a sell signal but a warning to investors to tighten their stops.

Sector Performance

Quarterly sales figures are only available to June 2016 but there are two stand-out sectors that achieved quarterly year-on-year sales growth in excess of 10 percent: Consumer Discretionary and Health Care.

S&P500 Quarterly Sales Growth

Interestingly, apart from Energy where there has been a sharp drop in earnings, sectors with the highest forward PE (based on estimated operating earnings) are the defensive sectors: Consumer Staples and Utilities. While Consumer Discretionary and Health Care are more middle-of-the-pack at 16.7 and 15.4 respectively.

S&P500 Forward PE Ratio by Sector

13 thoughts on “S&P 500 Price-Earnings suggest time to buy

  1. […] is reinforced by recent developments with the S&P 500 Forward Price-Earnings Ratio. I remarked at the beginning of February that the Forward P/E had dropped below 20, signaling a time to […]

  2. grahamdcox says:

    ‘Forward P/E for the S&P 500 is falling, ‘ Are you sure it has relative to say ten year Treasury IL yield.

    • ColinTwiggs says:

      Are you suggesting that low Treasury yields justify a higher P/E?

      I would prefer to use a more stable measure as a discount rate than Treasury yields which bounce up and down like a yo-yo depending on Fed monetary policy.

      • grahamdcox says:

        Sorry but Treasury yields are the discounts(s) rate, depending on which maturity or maturities you use. Ten year is the simple default one to use. . The dip in the PE (rise in earnings yield) yield simply reflects the rise in the Treasury yield since Trump arrived and Treasury yields started fallin agan recently and so supported the stock market. it is somewhat crazy to judge the market by the PE alone if T yields are moving. T Yields are the default opportunity cost, especially when cash return are close to zero

      • ColinTwiggs says:

        Good in the text books but not in practice. The Fed has T-yields on a string and can make them go pretty much where they wish. I doubt that many investment managers would use unadjusted T-yields as their risk-free rate of return and allow themselves to be led by the nose.

      • Graham Cox says:

        Did you listen to the Chair of the Fed on the subject?

      • ColinTwiggs says:

        “…Valuation metrics in some sectors do appear substantially stretched — particularly those for smaller firms in the social media and biotechnology industries, despite a notable downturn in equity prices for such firms early in the year.” – June 2014

        Fed’s Yellen: Stock Valuations ‘Generally Are Quite High’ – May 2015

        “In equity markets, valuation pressures have increased somewhat as expectations for corporate earnings have been revised downward,” the Federal Reserve Chairwoman told a Senate panel Tuesday. – June 2016


      • Grahan Cox says:

        No.On the subject of interest rates when she said she will raise the Fed Funds rate high enough so she can lower it if their planned run down of the balance sheet ( of the bonds bought ) accidentally causes economic weakness from the run-off pushing long rates higher. Bottom line, she wants to steepen the curve and you seem , unless i misunderstand, to think this is a good background for stocks .

      • ColinTwiggs says:

        I fully support the normalization of interest rates. Whether this will steepen the yield curve, I’m not sure.

  3. […] Forward P/E for the S&P 500 is falling, so I do not agree that valuations are spiraling out of control. But if, at some point, earnings take a hit, either from tighter Fed monetary policy or a trade war, then we are in for a wild ride. […]

  4. ColinTwiggs says:

    Someone sent me a question about the latest divergence between the S&P 500 index and its Forward P/E. Unfortunately I lost the email.

    Question: The current divergence appears to be one-of-a-kind, therefore would it be wise to assume that the result will be the same as past falls in Forward P/E.

    Answer: The index was far lower in the early ’90s so it may not appear similar, but the Forward P/E peaked and dipped below 20 while the Index was rising. Forward P/E was absolutely crazy during the 2000/01 Dotcom bubble and the 2008/09 Financial crisis, so it is difficult to compare these events directly. But each time the Forward P/E fell below 20 earnings started to rise. This provides some additional reassurance as the same pattern is emerging now.

    Hope you receive this. Apologies for losing the email. My Inbox gets very cluttered; far better to post questions here in the Comments section.

  5. Russ Abbott says:

    Interesting chart, but the first chart combines actual forward PE (green bars) with projected forward PE (orange bars). It would make more sense to look only at projected forward PE.

    • ColinTwiggs says:

      Yes. Unfortunately I do not have access to the history of projected earnings. These are continually revised by S&P. So there is a chance that the line will shift as projections are revised. I have recently been monitoring this but so far the revisions have been insignificant.

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