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Tuesday, December 01, 2009

Leonhardt on Long Term PEs

by Calculated Risk on 12/01/2009 10:04:00 PM

From David Leonhardt at the NY Times Economix: Stocks Start Looking Dear Again

Over the last few years, I’ve come to know and trust a version of the price-earnings ratio preferred by the economists Robert Shiller and John Campbell. It is based on an average of the past 10 years’ worth of corporate earnings, rather than just the past year (or a forecast of the next year’s earnings).
What does the ratio say today? That perhaps the recent rally has gone a bit too far.
You can read more about the history of this ratio, including the role played by the well-known Benjamin Graham and David Dodd, in this column from 2007, back when the bull market was still raging.
And from the earlier piece:
Benjamin Graham and David L. Dodd ... argued that P/E ratios should not be based on only one year’s worth of earnings. It is much better, they wrote in “Security Analysis,” to look at profits for “not less than five years, preferably seven or ten years.”
Just some ideas for discussion ...