Reliable Market Barometer Should Reassure Investors Price-Earnings Ratios Retreat From Highs Of A Few Years Ago

As scary as the stock market looks to many people at its current lofty levels, there is one gauge that suggests it isn’t so precariously priced.

That measure is the level of price-earnings ratios, a simple tool used to track where stock prices stand in relation to corporate profits.

While they have touched record highs in recent weeks, market indicators such as the Dow Jones average of 30 industrials and Standard & Poor’s 500-stock composite index carry much lower P-Es now than they did earlier in the ‘90s.

That’s because earnings of the companies whose stocks make up those indicators have climbed even faster than share prices. In the eyes of some optimistic analysts, the numbers imply that the market isn’t anywhere near as overextended as it is commonly presumed to be.

As October drew to a close, the Dow Jones industrial average was trading at less than 15 times the aggregate earnings over the past 52 weeks of its component companies, from AT&T to Woolworth.

That’s down from over 20 in the early 1990s and as high as 19 a year ago. A P-E of 15 stands at about midrange on the historical charts.

Similarly, the broader S&P 500 recently sported a P-E of about 16.8 to 1, down from 18.8 to 1 in October 1994.

A glance at the P-E trend serves as a calming antidote to some of the other figures used to take the market’s measure, such as dividend yields and price-to-book value ratios, which cast the market in a much more frightening light. But which gauge should an investor believe?

“Stocks are quite high on the basis of dividends and book value,” observes Yale Hirsch in his advisory letter Ground Floor, based in Old Tappan, N.J. “They are only modestly expensive based on earnings. But if this is the peak of the earnings cycle, then watch out!”

Indeed, most analysts agree that corporate earnings growth is in the process of slowing significantly. Some estimates call for increases of about 5 percent in 1996, down from the recent double-digit pace.

So if P-Es hold at their present level, the best that investors could theoretically hope for would be a 5 percent rise in stock prices next year as well.

P-Es are not static, however, but fluctuate constantly as investors’ expectations wax and wane. Many observers caution that a fairly modest P-E by itself can’t be taken as insurance against market risk. At bear market bottoms a couple of decades ago, P-Es got down to the neighborhood of about 8 to 1.