Replies to post #129850 on Zeev's Turnips Patch-No Politics (ZEEV)

[augieboo]

Richard, a 10-year PE is

P
-----------------------------
[10-year moving average of E]

Here's what Professor Shiller (of the Yale School of Management) says about why he uses 10-year PEs:

The simplest and most widely used ratio used to predict the market is the price–earnings ratio. The use of one-year's earnings in the price–earnings ratio is an unfortunate convention, recommended by tradition and convenience rather than any logic. As long ago as 1934, Benjamin Graham and David Dodd, in their now famous textbook Security Analysis, said that for purposes of examining such ratios, one should use an average of earnings of "not less than five years, preferably seven or ten years." (p. 452) Earnings in any one year tend to be affected by short-run considerations, that cannot be expected to continue. In the present time, earnings have suddenly shot up in the last few years, bringing price–earnings ratios down dramatically, but it is doubtful that such sudden changes are meaningful. We extend our moving average even further than Graham and Dodd did, on the supposition that even more smoothing is advantageous, and Graham and Dodd didn't have the data then to make such smoothing possible.

We chose to represent long-horizon returns, of ten years, since that is what really matters to most investors, because there is so much interest today in long-term investing, and because there is recent evidence in the statistical literature that the long-horizon returns are more forecastable. This may be contrary to one's expectations; one might have thought that it is easier to forecast into the near future than into the distant future, but the data contradict such intuition. This forecastability of the market is not the kind of thing that will enable us to forecast that a crash is around the corner; it is forecasting gradual trends, analogous to forecasting the prospects for a city based on population trends, or forecasting the success of a university in terms of the number of young people who are enrolling. (http://www.econ.yale.edu/~shiller/data/peratio.html; more at http://www.econ.yale.edu/~shiller/online/jpmalt.pdf)