Price to Earnings Ratios in the Stock Market Will Hit 50 to 1

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Apparently that is the conventional wisdom at my local NPR station (WAMU). A teaser for a talk show said something to the effect that "we all know that you put your money in the stock market and it goes up 8 percent a year." Well, those of us who were fortunate enough to get a 3rd grade education know better than this. Corporate profits on average increase at roughly the rate that the economy grows. Going forward, we are looking at annual GDP growth in a 2.5-3.0 percent range. Add in 2.5 percent inflation, and we get 5.0-5.5 percent nominal profit growth. If the market goes up more rapidly than this (as in 8 percent), then the price to earnings ratio must continually rise. If we go out thirty years, we'll be looking at the price to earnings ratios close to 50 to 1. We'll get PEs of more than 80 in fifty years. Do people at my local NPR station really expect that the PE in the stock market will exceed 50 before 2040 and reach 80 before 2060? It looks like that there are some great sales opportunities down there for stock pushers.

--Dean Baker

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