The numbers you see every day on the news reflect the price of the market, just like it reflects the price of a stock. But the price of a stock doesn't tell you if it's expensive or not.
Let's take two examples I love using: Apple and Whole Foods Market. Apple's stock price is around $120-130 these days, while the Whole Foods stock price is around $55. So, does Apple stock have more value?
No, Whole Foods is twice as expensive, even though it's half the price. When valuing a stock, we don't look at the dollar price, we look at the price as multiple of their earnings.
Apple's stock trades at a PE ratio of around 17 times its earnings, while Whole Foods trades at about 34 times earnings. That means you pay twice as much for Whole Foods Market's income stream than you're paying for Apple's. That's why Whole Foods stock is twice as expensive as Apple's. (And you thought only the stuff they sell was expensive.)
The stock market is nothing but the combination of all the stocks trading there. Like an individual stock, the market as a whole therefore trades at some multiple of the earnings of all those companies. These days, the S&P 500 (the total of the 500 largest stocks) trades at a multiple of about 17 times earnings. So, is that high or low?
This isn't something doomsdayers like hearing, but the market's PE ratio of 17 is pretty close to its historic average, as you can see from this chart:
Is the Stock Market Going to Crash Soon?
The chart clearly shows how the market's PE ratio went out of whack (scientific term, according to My Cousin Vinny) at the time of the major market crashes.
Let's take two examples I love using: Apple and Whole Foods Market. Apple's stock price is around $120-130 these days, while the Whole Foods stock price is around $55. So, does Apple stock have more value?
No, Whole Foods is twice as expensive, even though it's half the price. When valuing a stock, we don't look at the dollar price, we look at the price as multiple of their earnings.
Apple's stock trades at a PE ratio of around 17 times its earnings, while Whole Foods trades at about 34 times earnings. That means you pay twice as much for Whole Foods Market's income stream than you're paying for Apple's. That's why Whole Foods stock is twice as expensive as Apple's. (And you thought only the stuff they sell was expensive.)
The stock market is nothing but the combination of all the stocks trading there. Like an individual stock, the market as a whole therefore trades at some multiple of the earnings of all those companies. These days, the S&P 500 (the total of the 500 largest stocks) trades at a multiple of about 17 times earnings. So, is that high or low?
This isn't something doomsdayers like hearing, but the market's PE ratio of 17 is pretty close to its historic average, as you can see from this chart:
Is the Stock Market Going to Crash Soon?
The chart clearly shows how the market's PE ratio went out of whack (scientific term, according to My Cousin Vinny) at the time of the major market crashes.
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