Monday, March 2, 2009

Market Valuation

Sorry for the delay on this promised post, but today is the perfect day to encourage you (sarcasm) and say, I can't make the numbers work to justify the market being this high today. It should still go down more. As a disclaimer, I will be speaking specifically of the S&P 500 currently at $706.

Price Earnings Ratio ("PE") is simply the price of an investment divided by annual earnings. It tells you how much you are paying for each dollar of earnings. If PE is 10, it means for every dollar that stock earned last year, you must pay $10. It is useful as a comparison tool of how cheap or expensive the market is. Prior to the 1990's tops of markets had PE's of 12 to 16. Bear markets got as bad as 6 to 8 at the bottom before turning up. The past 20 years broke historical boundaries on the upside... exponentially. The PE of the market reached into the high 30's.

Last year the S&P 500 earned $72 per share. Assuming those 500 companies earn the same amount in 2009 as 2008, and a decline of PE down to 8, the market would hit $576. Put in your own assumption of how much earnings will decline this year and multiply by 8 to get the highest number the market is likely to be if fear is truly taking hold as in past bear markets.

If the range of earnings ends up somewhere between $40 to $55 per share this year, and assuming a PE range of 7 to 9, the low value for the market would be between $280 to $495. That means at least a 30% drop on top of today's current 4% loss. Of course we have 45 minutes so the market may be up 5% or down 10% for the day at close. Sorry for the bearish thought, but I am just telling what I see.