Investment Insights Multiple choice

Do investors place too much emphasis on the price to earnings (PE) ratio? With US equity multiples looking full, we take a deeper look at the PE ratio and assess its value to investors as a predictor of forward index returns.

06 Sep 2017
  • For equity indices the PE ratio is a useful ‘quick and dirty’ relative valuation measure
  • But one in isolation that fails to capture adequately the dynamic nature of corporate profitability
  • At the index level the PE ratio’s usefulness as a valuation tool is limited:

- Relative its own history by factors including changes to sector weightings over time

- Relative to international peers by additional factors including different tax regimes and accounting standards

  • More importantly our analysis shows no historical relationship between PEs and investment returns over tactical investment time horizons including three month, one year and three years
  • Only at valuation extremes and over a 10 year time horizon has the starting US PE had a strong statistical relationship with subsequent US equity index returns historically
    As a lead indicator for investor risk appetite and the Equity Risk Premium we also show that macroeconomic volatility has played an important role in determining index PE multiples
  • Looking forward we do not believe that the gradual unwinding of ultra-loose monetary policy globally, paced by the US, materially threatens the current low macroeconomic volatility backdrop in the developed world
  • While there are notable risks to global equities from geopolitics, we see continued low inflation and low rates helping to sustain higher PE multiples in the US in particular

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