Monday, April 20, 2009

What's the Real P/E Ratio?

The authors have a paragraph that is crucial to understanding investment returns going forward.
And a warning
From Barron's:

The bearish view on earnings makes the most sense.
...The best way to measure present earnings and future earnings is to smooth them out over long periods. Earnings can grow at only approximately 6% a year over the long term. The trend is limited by the growth in real GDP plus inflation. And long term, real GDP cannot grow faster than the increase in the labor force plus the increase in productivity.

If you don't accept this, look at a long-term chart and draw a 6% growth line through the earnings. It is clear that earnings sometimes rise above the line and sometimes fall below it, but earnings always revert to the 6% mean.

Going back to 1950, every instance where actual earnings rose above trend-line earnings was followed by a period where actual earnings went well below trend-line earnings.

Comstock Partners believes that we have entered such a period now, and that the market is trading at such a high multiple of trend-line earnings that it will be difficult to make money.

You could even lose a lot of money.

CHARLIE MINTER and MARTY WEINER are the chairman and president of Comstock Partners, investment managers in Yardley, Pa. Website:

HT: EconomPic

For portfolio investments the situation is even worse. The growth in real GDP includes the faster-than-aggregate growth of smaller companies. These tend to be privately held and are thus unavailable to investors in even the broadest based index.

These three points, growth of GDP, productivity and privately held companies are worthy of a post. I'll try to get to it within a month.