The S&P 500 Price to Earning Ratio is a popular financial metric that helps an investor to analyze the overall valuation of Standard & Poor’s 500 Companies. It is the Price to Earnings multiple of the S&P 500 constituents which helps investors to understand how the overall US Market is priced as compared to its earnings.
Historical P/E Ratio
According to historical data, the S&P 500 index average P/E ratio was 13.34 between 1900 and 1980, while the average ratio has changed to 21.92 (1981–2020) over the next 40 years. The highest ever ratio is 123.73 which was measured in May 2009 (after the market crash) and the lowest was 5.31 found in December 1917.
What is the S&P 500 PE Ratio?
PE Ratio is a financial metric that gives an idea about “what an investor is a ready pay to buy a share of a company based on earnings of the company”.
For example, if the PE ratio is 20, it means that an investor is ready to pay 20 times of company’s EPS (per-share earning) to buy a stock.
For reference, oil company Chevron has a 5-year continued profit of $10, $20, $35, $50, and $80. Let’s assume that the company’s current stock price is $1200 because the most recent earnings are $80, for that reason Chevron PE Ratio is $1200/$80 = 15. In other words, an investor who wants to invest in a Chevron company will get its money back over the period of 15 years according to the math.
S&P 500 PE Ratio Calculation
To analyze the ratio you need two types of elements, the current market price of the index, and S&P 500 EPS (Earning Per Share). After that, you can calculate the P/E Ratio using this formula –
How to Analyze It?
As long-term investors, we always look for companies’ fundamentals data and growth possibilities. The P/E Ratio helps us to understand the overall valuation of the S&P 500 Index.
By comparing S&P 500 PE ratio with historical data we can understand how the US Market is priced compared to history. It also helps us to identify the right time to buy stocks to make good returns.
The S&P 500 Average PE Ratio is 16.8 that means if the current P/E ratio is near the historical average then it may be a good time to invest because the market is fairly priced based on history. But on the other hand, if the P/E ratio is higher than the average, it indicates the market may be overpriced and prices may fall at some level.
1 Pic: Explain the level and impact of P/E ratio –
2 Pic: Comparison of two companies with PE ratio –
In simple words, the overvaluation of the price on the basis of earnings indicates a higher P/E Ratio whereas, in contrast, undervaluation indicates the lower or average ratio.
Price vs Earnings vs Interest Rate
In the process of wealth creation, no Investment decision can be taken on the basis of just PE ratio. You have to compare many different metrics and understand the relationship between them.
In the below chart you can easily compare and observe the S&P PE ratio with an all-important indicator –
The S&P 500 P/E Ratio is a good metric but we also need to understand the other fundamental data and technical analysis to see the clear picture and the above chart helps you to get this.