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Strategies & Market Trends : Buffettology
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To: jhg_in_kc who wrote (307)9/22/1998 1:38:00 PM
From: Robert Douglas  Read Replies (1) of 4691
 
Forgive me for stepping in to your discussion but I have to make one comment. You quote someone as saying:

The reason P/Es have expanded
over their historic averages is because long-term interest rates are
low. 30 year bonds are yielding a little over 5%! Invert that number and
you get a P/E (yes, the inverse of yield is P/E!!!) of 20x. Now, since
investors put money into equity markets in hopes of increases in future
earnings and cash flows, it makes sense that the current earnings yields
for equities would be lower than comparable yields for fixed income
securities. Put another way, if the 30 year bond has a P/E of 20, then
the stock market needs to have a P/E well in excess of 20.

I have always been under the impression that the higher risk investment would carry the lower P/E. Since you are comparing a bond's yield to the P/E of a stock, you must compare the relative risks of each instrument as well. Is there anyone here that doesn't know which is the riskier? Additionally, the premium paid for a growing stream of earnings would only be greater if the that growth rate is greater than the yield in question, in this case 5%. Is the long term growth rate of earnings going to be greater from this level? Perhaps, but not much more.

-Robert
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