It's important to keep this type of analysis in perspective. P/E ratios are just one of many factors you should consider. Shiller's observation that there were problems with the way that market average P/E ratios were being calculated prompted him to come up with the Shiller P/E, which uses the past decade's average inflation-adjusted earnings of stocks in the S&P 500. No matter which version of the P/E ratio you use, charting these ratios on a monthly basis will help give you additional, useful information for your investment strategy.
It's not a matter of when to get into the stock market, but of how — and how much. If you invest based on the right principles and use the right techniques, you have a better chance to protect against dire losses and capture good net returns in most types of markets. Here are some points to keep in mind:
• As the old saying goes, don't fight the tape (the market). Instead, try to capture returns based on what it's doing. This means playing the market up and down. If money is flowing into the market, this is a good sign that no correction is likely imminent. If money is flowing out of the market, a correction might be coming and it might be wise to convert some of your stock holdings to cash and offset risks on remaining stocks through shorting (making investments that essentially bet on their decline).
• Regarding precisely when to sell, develop a sell discipline that includes stop-loss limits – many successful investors sell their positions if they drop 8-10 percent from the purchase price. Whatever the percentage you choose, you must have the discipline to stick to that number.
• The market's direction always matters, but so does the advent of companies that represent a great investable proposition because they're doing something significantly different — either doing business in a dramatically different, highly effective way or coming up with products or services that are unique and highly attractive.
This column is the opinion of the author and in no way reflects the opinion of ABC News.
Byron L. Studdard, a CERTIFIED FINANCIAL PLANNER™ practitioner, is founder and president of Studdard Financial, LLC, a financial advisory firm in Sarasota, Fla., dedicated to helping clients build wealth, protect it and pass it on to future generations. Studdard is listed in the Guide to America's Best Financial Planners (published by the Consumers' Research Council of America, an independent research organization). He can be reached at Byron@studdardfinancial.com. If you have a question for him, send him an email and he will try to answer it in an upcoming column.