More on Dow stock valuation

Further to the assertion that stocks are reasonably valued, and Marc Faber's answer that we have an "earnings bubble" that is skewing p/e (share price compared to earnings, i.e. dividends) calculations, here is an essay by David Leonhardt in the International Herald Tribune (14 August) on historical p/e ratios.

A couple of extracts:

...the stocks in the Standard & Poor's 500 have an average P/E ratio of about 16.8, which by historical standards is normal. Since World War II, the average ratio has been 16.1. During the bubbles of the 1920s and the 1990s, the ratio shot above 30...

Graham and Dodd argued that P/E ratios should compare stock prices to "not less than five years, preferably seven or ten years" of profits...

Based on average profits over the past 10 years, the P/E ratio has been hovering around 27 recently. That's higher than it has been at any other point during the past 130 years, except for the great bubbles of the 1920s and the 1990s. The stock run-up of the 1990s was so big, in other words, that the market may still not have fully worked it off...

In the long term, the stock market will almost certainly continue to be a good investment. But the next few years do seem to depend on a more rickety foundation than Wall Street's soothing words suggest.

A drop from a p/e ratio of 27 down to 16.8 would imply a share price drop of 37%.

Thanks to Michael Panzner for spotting this and putting it onto his Financial Armageddon site.