Sunday, July 22, 2012

Investors Should Be Wary Of S&P 500 P/E Ratio

Every time you log-in to some financial news outlet, they have articles and live interviews with "analysts" who recommend buying equities in general based on a couple weak reasons. The most popular of those factors is perhaps the most flawed - the P/E ratio for the S&P 500. This number is compiled by dividing the price of the S&P 500 by the "expected" earnings of the companies that comprise the S&P 500 (with an emphasis on "expected"). The reliance of this model goes right out the window when corporate profits shrink. One cannot accurately gauge the direction of risk assets when the P/E is rising only due to declining earnings. The media will inevitably continue to mention the overall P/E ratio for the market, but as global economies shrink - it will be something the "analysts" speak of much less.

No comments:

Post a Comment