Why Use P/E10?

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Why Use P/E10?

JWR1945a 06-29-2008, 2:19 PM | Post #2533853 | 25 Replies

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From my web site:

Why Use P/E10?

Professor Robert Shiller came up with P/E10 as his measure of valuation. It is spectacularly successful. Its reciprocal, the percentage earnings yield 100E10/P, does the best job in predicting stock market returns and retirement financial success of all the measures that I have tested. Close contenders include the dividend yield equivalent 100D10/P and Tobin’s q.

P/E10 captures both the INVESTMENT RETURN and the SPECULATIVE RETURN of the stock market. The INVESTMENT RETURN equals the initial dividend yield plus the growth rate of the dividend amount. P/E10 or more specifically 100E10/P captures the initial dividend yield since dividends come out of (smoothed) earnings. The dividend growth rate of stocks overall (S&P500) has been remarkably stable at 5%. The SPECULATIVE RETURN reflects the effect of changing valuations. P/E10 and its reciprocal 100E10/P capture this effect as well.

A regression analysis (linear curve fit) shows that the percentage earnings yield 100E10/P estimates both Stock Returns and Historical Surviving Withdrawal Rates exceptionally well.

P/E10 or more specifically 100E10/P does a fantastic job of predicting what happens ten years from now (or even longer). What about the next year or two? It does not work in the short term. There is too much randomness for reliable prediction.

Is P/E10 usable over long periods of time? The answer is a resounding YES. You can wait twenty years on the sidelines and still be better off. It is that powerful.

Sensible use of P/E10 embraces gradually shifting stock allocations. It avoids all-in and all-out decisions. Rob Bennett named this Valuation Informed Indexing (VII or Lucky 7). It works with individual stock segments and with the stock market as a whole (S&P500).

Have fun.

John Walter Russell

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Re: Links to PE10

ladamson 06-30-2008, 9:29 AM | Post #2534026

Susan,

Here are the links. The first link has tabs at the bottom of the worksheet that contain charts and data tables.

The second link also contains links to Prof. Shiller's website.

http://www.econ.yale.edu/~shiller/data/ie_data.htm

http://www.early-retirement-planning-insights.com/why-PE10.html

Regards,

Lew

Related Topics charts yale

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Re: Yuck, no way

JWR1945a 06-30-2008, 10:33 AM | Post #2534040

I can't see myself sitting 80% in cash or bonds. No way, Jose. In the quest for the upside, I CAN see myself roaming more broadly into more adventurous areas like international, emerging markets or frontier markets (a little), precious metals and commodities. Inverse or bearmarket funds? Uh-uh. I've already been bitten a few times and I'd rather look for the upside.

I take from this that you are NOT withdrawing funds during retirement, but that you are accumulating funds. The two differ somewhat. Your need for safety differs as well.

Have fun.

John Walter Russell

Related Topics Funds Russell emerging markets commodities precious metals

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Re: Yuck, no way

JWR1945a 06-30-2008, 10:39 AM | Post #2534042

Correct me if I'm wrong, JWR, but P/E10 is a 10 year average P/E, or related to a 10 year average, possibly weighing later years more heavily.

P/E10 is the current price (index level) divided by the average of the previous ten years of earnings. Only the latest price. But with smoothed earnings. (All terms are adjusted to match inflation.)

This differs from the average of ten years of P/E values.

Have fun.

John Walter Russell

Related Topics Russell class P/E Microsoft Definitions

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Re: Re:Question for John.........

JWR1945a 06-30-2008, 10:49 AM | Post #2534045

John,

That is only somewhat helpful....Before 2000 covers a lot of ground. Can you give me a year when the S&P 500 stayed in the PE10 of 14 or less for an entire year? For example, what was the PE10 in 1990?

best,

Bill

(I suspect that you should be asking a different question.)

The source for P/E10 data is Professor Robert Shiller’s web site.

http://www.econ.yale.edu/~shiller/

P/E10 below 17 was in 1991.

P/E10 below 14 was in 1988.

January 1990 P/E10 was 17.05.

I do not know for entire years.

Have fun.

John Walter Russell

Related Topics Russell class Microsoft Definitions yale

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Re: Yuck, no way

bilperk 06-30-2008, 10:52 AM | Post #2534048

I'll ask again john, What was the PE10 in 1990?

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Re: Re:Question for John.........

JWR1945a 06-30-2008, 11:00 AM | Post #2534052

ElLobo provided an excellent summary.

In the early days, I referred to varying allocations with P/E10 as "switching." It produces a much better outcome, when looking for the highest levels of safety, than maintaining a fixed allocation. Roughly, it allows you to withdraw 5% per year (with adjustments to match inflation) when rebalancing would allow you to withdraw less than 4%.

It turned out that switching works with all S&P500 slices. It turns out that not-rebalancing is the best choice with all S&P500 slices. The reason is that better returning slices should be allowed to grow--if you can discern that they are more likely to grow--and you can.

I consider dividend and income approaches to be better overall. They allow for continuing withdrawal rates as opposed to 30-year withdrawal rates. But many people prefer a capital appreciation approach. With varying allocations, a capital appreciation approach can do quite well. Fixed allocations do not do nearly so well.

Have fun.

John Walter Russell

Related Topics dividend Russell capital appreciation rebalancing allocation

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Re: Yuck, no way

JWR1945a 06-30-2008, 11:04 AM | Post #2534054

We are posting at the same time, Bill.

P/E10 was 17 in 1990. More precisely, it was 17.05 in January 1990.

Have fun.

John Walter Russell