Knowing Your Personal P/E Ratio Can Bring Comfort in a Bear Market
The first half of the year was the worst for a balanced portfolio in decades, with both stocks AND bonds performing terribly. If there is any silver lining, it is that valuations have come down. That might seem obvious if your investments are down, but that is not always the case. Sometimes, companies can start earning much less, so valuations stay high even in a down market. In this bear market, earnings expectations have held up reasonably well.
As you can see from the chart above, the price-to-earnings (P/E) ratio of the S&P 500 has dropped to roughly 16. This is one graph where down is a good thing. It means you are paying less in price for the same earnings a company is generating. Unless you are a market timer, this is what matters over the long run – what profit are companies generating and how much do you have to pay to participate in that profit. Right now, you have to pay roughly $16 to get $1 per year in profit. That is fairly close to long-term averages.
But your personal portfolio P/E ratio may be different from the S&P 500. You may own some bonds and you might diversify into small caps and international as well.
For example, let’s assume a retiree has a $1,000,000 portfolio of 70% stocks and 30% bonds. For simplicity, let’s assume it is broken down into 30% large caps, 15% small caps, 15% international developed, 10% emerging markets, and 30% bonds. Based on the P/E ratios of those associated indexes and the yield of the bond aggregate index from the JPMorgan Weekly Market Update, the table below shows the estimated annual earnings from that portfolio.
The investments in this portfolio, even in a bear market, are still expected to earn money – almost $60,000/year. To be clear, this is not the dividends and interest distributed to the investor. A large chunk of the profit these companies make will be reinvested back into the company for future growth. For example, Apple keeps a lot of its profit so it can hire more engineers and create new products.
I like to reflect on this one idea during a market downturn - the companies I am invested in are still making money and it is reasonable to assume that at some point in the not-too-distant future, I will benefit from that – I just need to be patient.
Happy Planning,
Alex
This blog post is not advice. Please read disclaimers.