OPINION

Stock Market Insights

Dr. Richard L. Baker, AIF
Executive Vice President/Wealth Advisor at Prime Capital Investment Advisors
Obviously, the S&P 500 index, which follows the largest five hundred stocks in America, has increased a lot since 1996 and rose dramatically from March 23, 2020. But the most interesting part of this chart is what I have circled in the top right, the forward P/E ratio.

What’s the story behind the story? There are a lot of interesting things to see in this graph. Obviously, the S&P 500 index, which follows the largest five hundred stocks in America, has increased a lot since 1996 and rose dramatically from March 23, 2020. But the most interesting part of this chart is what I have circled in the top right, the forward P/E ratio.

The forward P/E is a ratio of price-to-earnings using forecasted earnings for its calculation. As of June 8, 2021 the S&P’s forward P/E ratio is 21.5x. Numbers are numbers, but when they are compared to themselves at different times, we see a story.

Here is what that means to me. The S&P’s forward P/E ratio 25-year average is 16.71x. Generally, when this ratio gets close to 13.0x I feel the stock prices are too low for how much earnings the stocks are getting and feel like it is a time to buy more stocks. When this ratio goes above 20.0x I feel the stock prices are high for how much earnings the stocks are getting and feel like it’s a time to start selling some stocks. So, when I see the current ratio above that mark at 21.5x I would normally be getting nervous, but this time I’m not because I know the story behind the story.

The S&P 500 index does, as the name implies, have 500 stocks in it, but they aren’t equally ranked. The story behind the story is that though the S&P as a group is at 21.5x the majority of them aren’t. If you took out the top 10, which are mostly tech stocks like Apple, Microsoft, Amazon, Facebook, and Google, the remaining 490 stocks have a forward P/E ratio of 19.2x. Which is still a little high but not terribly. The top 10 stocks alone have a forward P/E ratio of 28.6x which is alarmingly high.

My mom always told me not to assume and she was right. Just because some stocks are out of whack doesn’t mean all the stocks are. Sometimes the story isn’t so scary when you know the story behind the story.

Have a blessed week!

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