Is Today’s Price-Earnings Ratio Too High?

Richard W. Kopcke Zhenya Karamcheva

IB#11-7

The brief’s key findings are:

  • To assess whether stocks are overvalued, analysts often compare stock prices to companies’ cyclically-adjusted (10-year average) earnings.
  • Today’s ratio of stock prices to cyclically-adjusted earnings appears high, which has often signaled a pending fall in prices.
  • However, cyclically-adjusted earnings are unusually low right now because they include two recessions.
  • As the recession of 2001-02 is replaced by higher earnings, the price-earnings ratio will drop back to its historic average by the end of 2012.