Leaving aside the European mess, Chinese slowdowns, and faux fiscal cliffs, stocks appear cheap on a price to earnings (P/E) basis. Calculated by simply dividing the level of the S&P500 (^GSPC) by total earnings stocks are trading at a P/E of 12x --14% below the historical average of 14x. So stocks are a buy, right?
According to Lincoln Ellis of the Strategic Financial Group, the P/E game is a sham, starting with the notion that 14x is a genuine average.
"That multiple is really only indicative of the last 25 years" Ellis says in the attached video. "We are in a very difficult and different environment."
Looking at the less bullish era from the 1950s to the early '80s stocks traded around 10x, a valuation Ellis believes to be more applicable today. Calling low P/Es a "siren song" luring investors to their doom, Ellis advises investors to take a cue from the late Baron Biggs and do more legwork before diving in blind.
For a more useful measure of how expensive the market is Ellis suggests the Shiller P/E which adjusts for inflation for the last 10 years. By that gauge stocks are trade at 22x, well above their historical average.
The bottom line is that P/E is at best, one part of huge number of factors that go into deciding whether or not stocks are "cheap." Anyone who tells you otherwise is selling you something you shouldn't buy.
