Stocks are relatively cheap as measured by S&P 500 P-E

ByABC News
December 15, 2011, 8:10 PM

— -- Q: What's the stock market's price-to-earnings ratio right now? When was the market's P-E at its highest? When was it at its lowest?

A: When you hear investors ask if stocks are cheap or expensive, what they're really asking is what is the market's P-E.

The stock market's price-to-earnings ratio is just a measure of how much investors are paying for stocks. Specifically, the P-E tells you how much investors are paying for a claim to every dollar companies' have earned.

Investors routinely consider the P-E ratio of individual stocks when deciding whether or not to buy them. But some investors also pay attention to how much investors are paying for stocks at large. And one of the best ways to do that is to examine the P-E of a broad stock market index like the Standard & Poor's 500.

There are many ways to calculate a P-E ratio. But for this question, we'll take a look at the P-E of the S&P 500 based on what companies have earned over the past 12 months.

We'll start, first, by measuring the denominator of the equation, which are companies' earnings over the past 12 months. Companies have earned $94.66 a share through the third quarter of 2011. That sum then divided by the present value of the S&P 500 index, which is 1215.75. The division problem tells you that the present trailing P-E of the S&P 500 is 12.8.

Just looking at a P-E in isolation, though, doesn't tell you much. Typically, the ratio is compared with the market's valuation at different points in the past to glean insights.

Historically speaking, the market's P-E is pretty low. The market's P-E, on a trailing basis, has been 19.2 on average since 1988, says S&P. That tells you that the stock market is currently on sale by 33% relative to the past 23 years of history.

What about the highs and lows of the market's valuation? The S&P's highest P-E occurred during the fourth quarter of 2001, when investors were paying a 29.55 P-E. And the lowest valuation? That happened in the fourth quarter of 1988, when investors paid just a 11.5 P-E multiple.

So, as you can see, the stock market is certainly discounted relative to its historical average. However, it has been cheaper in the past.

Matt Krantz is a financial markets reporter at USA TODAY and author of Investing Online for Dummies and Fundamental Analysis for Dummies. He answers a different reader question every weekday in his Ask Matt column at money.usatoday.com. To submit a question, e-mail Matt at mkrantz@usatoday.com. Follow Matt on Twitter at: twitter.com/mattkrantz