Author Topic: S&P PE vs CAPE  (Read 1322 times)

the_gastropod

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S&P PE vs CAPE
« on: July 14, 2022, 03:36:23 PM »
I’m feeling a bit like an idiot trying to understand what’s happening. Can anyone ELI5 why the S&P 500 P/E values (https://www.multpl.com/s-p-500-pe-ratio ) are looking faaaaaairly decent now compared to the past 40 years (and only ~18% above the mean since 1870). That paints a relatively pretty rosy picture. The CAPE (https://www.multpl.com/shiller-pe), on the other hand, is still a staggering 75% above the mean. Are earnings, right now, extraordinarily high? What gives?

the_gastropod

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Re: S&P PE vs CAPE
« Reply #1 on: July 14, 2022, 04:16:53 PM »
I didn’t realize until just now that this same website has the S&P earnings, too! https://www.multpl.com/s-p-500-earnings

Indeed, earnings have skyrocketed this past year. So today’s crazy-high earnings make today’s price seem reasonable. But averaged with the previous 9 years earnings, we’re still priced pretty high.

MustacheAndaHalf

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Re: S&P PE vs CAPE
« Reply #2 on: July 14, 2022, 06:32:45 PM »
I found it interesting to compare Vanguard Value (VTV) and Vanguard Growth (VUG), with P/E ratios of 14.3 (VTV) and 23.4 (VUG) currently.  Somewhere I also saw a graph showing the growth vs value P/E gap, and current levels are the highest since just before the dot-com crash corrected it.
https://www.morningstar.com/etfs/arcx/vtv/portfolio
https://www.morningstar.com/etfs/arcx/vug/portfolio

Part of the market expects recession, in which case earnings could be more impacted than current predictions.  And in general, the historical average P/E by definition is a point where P/E values spend time below the average.  If stocks always recovered when they hit the average, it wouldn't be the average. (Which is not a point you raised, but something I hear too often from professional investors)

vand

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Re: S&P PE vs CAPE
« Reply #3 on: July 15, 2022, 12:15:17 PM »
one of the things that has charaterised the bull market is the high and increasing profit margin level - big techs have astounding profit margin compared to what we had previously known that it overall it increased the S&P margin by a few percent past anything we had seen before in just the last few years.   This has kep the vanilla p/e looking reasonable while leaving it expensive on many other metrics like price/sales and buffett indicator (price/GDP) as well as the CAPE10 variant.

It's not just big tech either, many established companies were able to push up their profit margins just through financial leveraging due to the cost of capital going so low.

ChpBstrd

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Re: S&P PE vs CAPE
« Reply #4 on: July 15, 2022, 02:21:22 PM »
one of the things that has charaterised the bull market is the high and increasing profit margin level - big techs have astounding profit margin compared to what we had previously known that it overall it increased the S&P margin by a few percent past anything we had seen before in just the last few years.   This has kep the vanilla p/e looking reasonable while leaving it expensive on many other metrics like price/sales and buffett indicator (price/GDP) as well as the CAPE10 variant.

I agree. As early investors in Microsoft learned, when your cost of good sold is almost entirely a fixed cost, and you can copy software for almost nothing every time you make a sale, then margins and profits can go through the roof. Additionally, growth is uninhibited by physical constraints, such as the need to build distribution networks. Do such companies deserve a higher valuation than, let's say, a steel mill or a tractor manufacturer? Definitely. What happens when the market becomes dominated by such high-margin, growth companies? The indices get a high PE ratio and the rapid earnings growth, in addition to higher stock valuations, blows up the CAPE ratio. Eventually the indices look like a fast-growing tech company themselves, and are no longer comparable to the indices of decades ago.

So maybe the value stocks @MustacheAndaHalf cites with a PE of 14.3 are a decent proxy to compare with value stocks in earlier decades to decide whether stocks are expensive, and maybe CAPE is too distorted by changes in the composition of the indices to be of use?

It's not just big tech either, many established companies were able to push up their profit margins just through financial leveraging due to the cost of capital going so low.


Yea, this terrifies me. When interest rates are low, the way to optimize return to stockholders is to increase leverage. A popular management trick of the past couple of decades has been to borrow from the bond markets and use the money to buy back stock. Obviously there is a tipping point where leverage no longer adds value, but that tipping point is higher when interest rates are lower. What happens if there is an increase in rates after everyone has been doing this a while? Then, companies across the markets will be motivated to pay down debt, because the optimal capital structure will be a lower debt to equity ratio when debt is expensive. De-leveraging costs a fortune. It would either pull cash away from stockholders or dilute them. If de-leveraging could not be done, such as in cases where the company lacks the earnings to pay down its debt quickly, then stockholders would have to give back the capital gains they've enjoyed for many years and companies would become trapped in debt. A rising-rates, falling-earnings environment would trap a lot of companies.

Thus, if rates are rising, I have to think about the companies I own either de-leveraging at great cost to my cash flows, or even worse, not de-leveraging and sitting around helplessly while earnings get consumed by ever-rising interest expenses.

MustacheAndaHalf

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Re: S&P PE vs CAPE
« Reply #5 on: July 16, 2022, 01:13:44 AM »
In Larry Swedroe's books I've read various reasons P/E values from long ago can't be compared to current P/E values, including things like major accounting changes.

But I wondered how much the top S&P 500 companies are distorting P/E values, so I looked at "consumer discretionary" as a sector and its top two companies.  The overall sector has a 21.99 P/E value, call that 22 P/E ratio.
https://www.morningstar.com/etfs/arcx/xly/portfolio

The sector's largest companies are Amazon (55 P/E ratio) and Tesla (98 P/E ratio).  How much does that matter?  Those two companies are 40% of the sector by market cap!  Which isn't a big surprise when the third and fifth largest public companies crowd into the same sector - but it definitely impacts P/E values for the sector.
https://www.morningstar.com/stocks/xnas/amzn/valuation
https://www.morningstar.com/stocks/xnas/tsla/valuation

Full_Beard

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Re: S&P PE vs CAPE
« Reply #6 on: July 18, 2022, 09:09:00 PM »
I’m feeling a bit like an idiot trying to understand what’s happening. Can anyone ELI5 why the S&P 500 P/E values (https://www.multpl.com/s-p-500-pe-ratio ) are looking faaaaaairly decent now compared to the past 40 years (and only ~18% above the mean since 1870). That paints a relatively pretty rosy picture. The CAPE (https://www.multpl.com/shiller-pe), on the other hand, is still a staggering 75% above the mean. Are earnings, right now, extraordinarily high? What gives?
12-month trailing p/e vs 10-year.

The 12-month trailing p/e is not a great analytic tool.

grantmeaname

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Re: S&P PE vs CAPE
« Reply #7 on: July 19, 2022, 05:47:14 AM »
Real market participants use the forward multiples anyway. It's just much harder to get the data.