Rather than comparing P/E to History, Compare Earnings Yields to Treasury Yields

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Solid post. I’m often frustrated when people point at various price ratios as an indicator of impending doom because they ignore one important thing – the value of money. If a currency is being devalued, prices WILL rise by definition because we measure price in currency. When the price of everything goes up simultaneously, that doesn’t mean the assets became more valuable- it means what they are measured against, the currency , became less valuable. Therefore it is pointless to look at historical ratios unless you adjust for the value of money.


Using this metric, stocks were expensive in the fall of 1982 – 14.3% Earnings yield vs a 14.4% UST yield. Stocks returned an average of 20% CAGR from there until the Dotcom highs. An earnings yield of ~4% is likely the returns you can expect from here.


In this market, where investors are desperate to find real value, anything that is still left on the “value” rack is something with severe flaws that will lead to declining future earnings and explain its pricing. Earnings yield for many marginal companies has been so manipulated via stock buybacks made with borrowed money that they are not a good proxy for the strength of the underlying companies. IBM is the poster boy for that strategy. They spent many billions on buybacks, and it’s periodically touted as a great value stock. Even Buffett fell for that swindle. It is currently down 25% from where it was 5 years ago during a time when the market as a whole has soared. Value is more than just a low P/E. Its a combination of a low P/E with a strong business that is using its cash intelligently to grow the business.


I’m more of a CAGR person myself


Agree completely. I own some cheap companies with good growth (I guess the market does not believe they can sustain it, but I believe in them), but mostly cash machines that will keep printing in the coming years. And those are quite cheap. Not always single-digit PE super cheap, but close. Also, I think commodity plays are still cheap because the whole green future thing will eat enormous amounts of copper, nickel, silver etc.