Behind the numbers

With Tim Koller

After a series of record-breaking closes for US stocks and the prospect that lower corporate tax rates might continue to boost markets, investors had plenty to be excited about as 2017 drew to a close. But the run-up has also spurred growing concerns of a bubble in overpriced shares. At the time of this writing, the S&P 500 index’s one-year-forward price-earnings (PE) ratio stood at 18.6, higher than in the majority of years over the past five decades.

Yet it bears remembering that the headline number was misleading during the dot-com bubble around the turn of the century. And it may be so again. By digging deeper into what is behind that PE ratio and putting it into a context that includes the real economy, a picture of market value begins to emerge that doesn’t seem so extreme. Executives should focus on their companies’ and industries’ value, not markets as a whole. That said, additional perspective can help investors and strategic planners alike make better decisions.

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