Ok. Essentially, the question boils down to-- why would you ever pay for a P/E higher than the "P/E" of a bond? For this discussion, I'm going to use 10 year bonds. That's what the Fed uses and there's a whole bunch of reasons, many of which I don't understand.
Currently, bond P/E's are 1/(6%) or 16.7 The reason you pay a higher P/E for a stock is that you hope that eventually the earnings on the stock will rise. Say a stock earns $3 a share, and will earn $3 a share for the next 10 years. How much is the stock worth? Well, I could pay $50 for a bond that gives me $3 (6% of 50 is 3), so I shouldn't pay more than $50 for that stock.
Now work this backwards. Someone pays $50 for a share of stock. If they expected less than $3 for a share over the next 10 years, they should have bought the bond instead. They would earn more. So the implied expectation of the purchaser is that this stock will earn at least $3 per share.
Microsoft sells for $120. The implied expectation is 6% of $120 or $7.20. If you don't expect Microsoft to earn an average of $7.20 per share for the next 10 years, you're better off buying $120 worth of 10 year bonds, which will pay $7.20 for 10 years.
Of course, if you treat stocks like baseball cards or artwork, and not like financial instruments, then the above discussion is moot. |
