S&P 500 Price to Earnings Ratio

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Interpretation

The price earnings ratio is calculated by dividing a company's stock price by it's earnings per share. In other words, the price earnings ratio shows what the market is willing to pay for a stock based on its current earnings. It is one of the most widely-used valuation metrics for stocks. The PE ratio of the S&P 500 divides the index (current market price) by the reported earnings of the trailing twelve months. In 2009 when earnings fell close to zero the ratio got out of whack. A solution to this phenomenon is to divide the price by the average inflation-adjusted earnings of the previous 10 years. In recent years, Yale professor Robert Shiller, he author of Irrational Exuberance, has reintroduced this adjusted ratio to a wider audience of investors. The Shiller PE Ratio of the S&P 500 is illustrated below.

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The Shiller PE Ratio

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Interpretation

Instead of dividing by the earnings of one year (see chart above), this ratio divides the price of the S&P 500 index by the average inflation-adjusted earnings of the previous 10 years. The ratio is also known as the Cyclically Adjusted PE Ratio (CAPE Ratio), the Shiller PE Ratio, or the P/E10.

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