Over at the NYT, David Leonhardt reminds us that stock prices still look rich by some measures even as we hover near November's lows. That's because price-to-earnings ratios may be sinking, but they're still barely cheaper than long-term averages. Based on historical 10-year averages of S&P earnings, Leonhardt also says stocks still haven't gotten as cheap as they did in past downturns. The bad news (bold is mine):
By this measure, the p-e ratio of the S.&P. 500 is now about 14.5. It’s below average, but not enormously so. By comparison, this ratio fell to 6 during the 1930s and 7 during the early 1980s. In short, stocks are a little less expensive than their historical average. But they are far more expensive than they were at the worst points of the other two worst recessions of the past century.
How could this be? The main answer is that stocks were incredibly expensive before the current crisis began — more expensive than at almost any other point in the last 100 years, save the bubbles of the 1920s and 1990s. They had a long way to fall. The fact that earnings are falling — and may well remain low for the next several years — doesn’t help either.
It's important to remember using short-term p-e ratios (like those posted on most popular finance sites, which are often based on a single year's earnings) don't tell investors very much when share prices and earnings are highly volatile over a limited period. Even using them as a comparison tool for companies in the same industry becomes less useful during a downturn like this one where macroeconomic factors play a bigger role than company fundamentals.
The bottom line: For stocks, cheaper still doesn't mean cheap.
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