Economist Robert Shiller, in his book Irrational Exuberance,
analyzed the relationship between Price-Earnings ratio for the S&P500 and future returns on those stocks.
Using historical data, he tracked a trading strategy that invested in January of a given year and then held for 10 years. For years in which the PE for the S&P 500 was higher than 20 (which is somewhat, though not more than twice, the historical average), the ensuing ten years typically showed very low compound annual returns. In fact, of the 16 years in which the PE was higher than 20, only two of these 16 purchases would have enjoyed a compound, real return of more than 5%--and even these two showed returns of only a little more than 5%.
At the same time, buying when the PE for the S&P 500 was low -for example, lower than 10 - produced real returns in excess of 5% in all 16 of the years in which that strategy would have purchased stocks. Half of these ten-year real returns, in fact were, higher than 10%.
Economist Robert Shiller, in his book Irrational Exuberance,
analyzed the relationship between Price-Earnings ratio for the S&P500 and future returns on those stocks.
Using historical data, he tracked a trading strategy that invested in January of a given year and then held for 10 years. For years in which the PE for the S&P 500 was higher than 20 (which is somewhat, though not more than twice, the historical average), the ensuing ten years typically showed very low compound annual returns. In fact, of the 16 years in which the PE was higher than 20, only two of these 16 purchases would have enjoyed a compound, real return of more than 5%--and even these two showed returns of only a little more than 5%.
At the same time, buying when the PE for the S&P 500 was low -for example, lower than 10 - produced real returns in excess of 5% in all 16 of the years in which that strategy would have purchased stocks. Half of these ten-year real returns, in fact were, higher than 10%.
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