How to Take the Market's Pulse
The most useful price-earnings ratio.
The price-earnings ratio is a key measure of the stock market’s value. But some P/Es are more meaningful than others. Below, we look at five ways to determine the P/E of Standard & Poor’s 500-stock index, based on five ways of calculating the all-important E. P/Es are as of April 9, 2010.
23.4 The Kitchen-Sink P/E
E based on past earnings as reported. The figure used here, also known as trailing earnings, reflects profits in the previous four quarters, a number that has been depressed recently by the recession and huge write-offs. This profit number is based on generally accepted accounting principles. At any rate, investors look ahead, and this P/E looks backward. Usefulness: MINIMAL
21.0 The Clean P/E
E based on past earnings from operations. This profit number is also based on the previous four quarters of activity. But it excludes write-offs and other extraordinary events, so it reflects reality better than the P/E based on reported earnings. Like that figure, however, it is backward-looking. Usefulness: MINIMAL
18.8 The Rube Goldberg P/E
E based on average earnings over a long economic cycle. This figure is based on the work of the Leuthold Group, which uses 4.5 years of actual results and six months of estimated profits to determine the E. Although Leuthold’s numbers mostly look backward, they do capture the ups and downs of economic cycles. Usefulness: GOOD
15.3 The Guru P/E
E based on strategists’ earnings forecasts for 2010. This profit number represents the average earnings for the S&P 500 as estimated by brokerage-firm strategists. It’s forward-looking -- a plus because it’s in sync with the way investors operate. Strategists tend to be late in catching on to major turns in the economy. Still, this is OUR FAVORITE P/E.
14.8 The Rose-Colored-Glasses P/E
E based on earnings estimates for 2010 by company analysts. Earnings are based on estimates for each company in the S&P 500, which are then added together and weighted according to company size. The P/E is forward-looking, but analysts tend to be overly optimistic about the companies they follow. Usefulness: SO-SO