As we’ve often noted, Price Earnings (PE) ratios provide a useful but often incomplete picture of whether a market is cheap or expensive. For one thing, the PE is a multiple of consensus earnings forecasts, and those forecasts can be wrong. Indeed, if a recession hits, the earnings expectations are likely to be revised lower in a hurry. Secondly, investment returns are often highly dependent on movements in interest rates, as we all know.
That said, the PE ratio, with all its many limitations, still paints an interesting picture. Here are a couple of charts covering the ASX 100 index, sourced from Shaw and Partners, as of the end of May 2023. It shows the PE at 14.6 times, which is around the long-term average. The chart includes Shaw’s estimate of where “fair value” sits and implies that “Total Shareholder Return” anticipated over the next 12 months is at almost 15%.
Source: Shaw and Partners
Looking at the PE ratio over a much longer period (since 1937, or over 85 years):
Source: Shaw and Partners
At a glance, to my eye, the market tends to range mostly between 15x to 20x, apart from a few exceptions such as the very slow recovery from the 1973 oil price shock and subsequent long recession. But trying to time the market using an approach like this is likely to be fraught with missteps, and it is far better to concentrate one’s attention on individual companies and ascertain whether or not they represent good value and high quality based on fundamentals such as the experience of management, consistency of revenue and earnings, resilience of business model, soundness of balance sheet, and so on. Unfortunately in markets, there are seldom useful shortcuts!
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