Jul 16, 2013

S&P 500 Valuation using Relative Value Method (using Price/Earnings PE ratio)

We talked about valuing S&P 500 Intrinsic valuation in the previous post, lets value the S&P 500 index using relative value method in this post.

We can use many valuation measures for comparing the value of the security against other securities or against the security's historical values. Though ratios like Price/Book value or Price/Sales or Price/Cash Flow can be used a measure to compare, Price/Earnings (P/E) is by far the most popular valuation measure today.

The Excel spread sheet shows the current P/E ratio for S&P 500 and the valuation for S&P 500 based on historical P/E ratio Averages. The data source for the calculation is from:  http://www.spindices.com/indices/equity/sp-500.

Legendary value investor Benjamin Graham and others have proposed using 10 year average earnings in the denominator of the P/E so that it accounts for the fluctuations in the Business cycle. This ratio is generally denominated as "P/E10". Valuation of S&P 500 based on P/E10 is also shown at the bottom of the table.