P/E Ratios Are Effectively Worthless

I wanted to show you this passage from an article criticizing the Fed model as a valuation metric.

The Fed model fares poorly compared with simpler methods of judging when stocks are attractive. A study by Bank of America found that as a tool for predicting 10-year returns, P/E ratios were 10 times more accurate as an indicator of what stocks would do, while metrics like price to book value did even better. The S&P 500 trades for 20 times annual earnings, the highest P/E since 2009, and 2.9 times book, or assets minus liabilities.

In many respects, the case against the Fed model is the same as the case against any investment strategy predicated on valuation: they’re fraught with false signals. Data compiled by Bloomberg show that even the most conservative applications of price-earnings ratios as a buy or sell indicator are effectively useless for predicting how stocks will perform in the coming year.

Posted by on August 8th, 2016 at 7:25 pm


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