spx earnings expansion PE: How Much Did an Expansion in the PE Multiple of the S&P500 Contribute to Stock Market Returns Over the Past Decades?

How Much Did an Expansion in the PE Multiple of the S&P500 Contribute to Stock Market Returns Over the Past Decades?

(Hint: A Lot)

The excess returns of stock market investors over the past 2 decades have been from an expansion of the PE ratio of the S&P500. The figures are striking and best summarized in the following table:

	S&P500:	Earnings:	PE:	If 1982 PE:
1982	120.40	15.13	8.0	120.4
1995	470.42	30.88	15.2	245.7
9/2000	1439.03	56.13	25.6	446.6
	% Change in:			Expansion
	S&P500:	Earnings:	PE:	Proportion:
1982-95	291%	104%	91%	47%
1995-9/00	206%	82%	68%	46%
1982-9/00	1095%	271%	222%	45%

What this shows is the S&P500 and trailing 12 month earnings for January, 1982, January, 1995, and September, 2000 (as of last week). From 1982 to the present, the S&P500 soared 1,095%. Earnings, however, grew only 271%. If it had not been for a 222% growth in the PE ratio, the market would have only grown much less. If today's market had the same PE it had in 1982, the S&P500 would be only 446.6, less than one third of its present value! Granted, a PE of 8 is about half the post-World War II median, but even a PE of 15 would bring the market down to 842, about 41% below current levels.

Now we may be in a new paradigm but what is striking to those of us who still care about such things as price earnings ratios and such is how new the paradigm is.

Ultimately, the PE is a psychological barometer, a measure of people's appetite for stocks. If people really want to own stocks, they will pay more for a dollar of a company's earnings. If stocks are shunned for whatever reason, investors will pay less. People in the past have swung from extreme despair (1973-1974) to extreme euphoria (in March, 2000, the S&P500 PE ratio hit 34.1! There is no reason to think that basic human nature has changed, so I would rather stake the future of my retirement on something less fickle than the emotions of the crowd.

That's why in the end I think that you can't realistically expect to earn more than the underlying aggregate corporate growth rate. (And you can't really add dividends since dividends are nothing more than a form of distribution of earnings in the form of cash instead of capital appreciation.)

Mark Vakkur