Decomposing the S&P 500 PE Ratio: How Can the Market PE be “Low” and Stocks be Expensive at the Same Time?December 12, 2013
One unfortunate reality of market cap weighted indices is that statistics derived from these indices are inherently skewed by a handful of megacap companies. The P/E ratio is no exception. What we find is that the top 10 companies in the index comprise 18.5% of the market cap and 21.4% of the earnings, and these companies have an average forward P/E of 14.3. On the other hand, the bottom 450 companies, which comprise only 52% of the market cap and 47% of the earnings, sport a forward P/E of 21.4. When all company’s earnings are contributed into the market P/E calculation the result is a P/E ratio of about 15. This P/E ratio could be viewed as “low” relative to all-time peak valuation of around 25 in 1999, but we highlight valuations topped out at about 16 in 2007. Furthermore, with the average stock trading at more than 20x next year’s highly subjective earnings, it’s easy to call the average stock “expensive”.