- Anincrease in expected growthin earnings across
firms will result in a higher P/E ratio for the market. - Anincreaseinthereturnonequityatfirmswillresult
inahigherpayoutratioforanygivengrowthrateand
a higher P/E ratio for all firms.
Inotherwords,itisdifficulttodrawconclusionsaboutP/E
ratios without looking at these fundamentals. A more
appropriatecomparison istherefore not betweenP/E ratios
acrosstime,butbetweentheactualP/Eratioandthepredicted
P/E ratio based on fundamentals existing at that time.
ILLUSTRATION8.6:P/ERatiosacrossTimefortheS&P
500
While P/Eratios aremorewidelyusedin practice,market
strategistsoftenprefertofocusontheinverseofthenumber,
theearnings-to-price(E/P)ratio(ortheearningsyield).To
illustrate,aP/Eratioof 20 translatesintoanearningsyieldof
5%,which,inturn,canbecomparedtothedividendyieldor
theTreasurybond(T-bond)rate.Figure8.14summarizesthe
earnings/priceratiosforS&P 500 andTreasurybondratesat
the end of each year from 1960 to 2005.
FIGURE8.14Earnings/PriceRatiosandInterestRates:S&P
500, 1960–2005