Tags: Siegel | Shiller | PE | stocks

Siegel: Shiller's P/E Ratio Provides Distorted View of Stocks

By Dan Weil   |   Wednesday, 21 Aug 2013 11:50 AM

The long-term price-earnings (P/E) ratio developed by Yale economist Robert Shiller points to a decline for stocks, but that ratio is distorted, says Jeremy Siegel, a finance professor at Wharton.

"The bears claim that current earnings are unsustainably high and can be expected to fall," Siegel writes in the Financial Times. "Bulls, including myself, believe earnings are unlikely to fall and higher P/E ratios may propel stocks even higher."

Shiller's P/E ratio, known as the cyclically adjusted P/E (Cape) ratio, utilizes the average of the past 10 years for earnings in order to adjust for temporary fluctuations in profits caused by business cycles.

Editor’s Note:
Forbes Columnist: ‘Who the Hell Cleared This?’ (See Shocking Video)

The Cape ratio has a bearish bias, Siegel says. "In all but nine months in the past 22 years, the Cape ratio has been above its long-term average, and the ratio currently predicts well below-average stock returns."

The problem is tainted earnings data, Siegel explains. "Changes in the accounting standards in the 1990s forced companies to charge large write-offs when assets they hold fall in price, but when assets rise in price they do not boost earnings unless the asset is sold."

That means the earnings part of Cape ratios is artificially depressed, Siegel argues.

Like Siegel, Anthony Chan, chief economist for JPMorgan's Chase Private Client, sees P/E ratios at attractive levels for stocks.

"Based on earnings that we expect to see this year, we look at price-earnings ratios that are just a little bit above 15," he says on 4-traders.com.

"And given that the historical average over the last 15 years is about 16.4, these numbers suggest to me that while the market is not likely to move in a straight line between now and the end of the year, we can still justify 8 to 10 percent rates of return every 12 months."

Editor’s Note: Forbes Columnist: ‘Who the Hell Cleared This?’ (See Shocking Video)

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