How much would you pay me for a stock that earns $1 per share per year? No, that doesn't mean it pays out a dividend of $1 per year. It just earns that much, regardless of whether it pays out the earnings as dividends.
The market determines how much you have to pay. Sometimes, you have to pay $25 for that stock earning $1. Sometimes, you only have to pay $15 for that stock. Historically, the market peaks at $20, which means it is selling at a PE (Price Earnings) Ratio of 20 times. Now, take a look at this graph showing the Price Earnings Ratio since 1900:
The market determines how much you have to pay. Sometimes, you have to pay $25 for that stock earning $1. Sometimes, you only have to pay $15 for that stock. Historically, the market peaks at $20, which means it is selling at a PE (Price Earnings) Ratio of 20 times. Now, take a look at this graph showing the Price Earnings Ratio since 1900:
You can see in the late 1990s, during the internet bubble, when the PE Ratio reached an astronomical 40 times earnings. You can also see the huge spike that occurred in 2009 when stock prices actually fell faster than Earnings Per Share (EPS) could be reported quarterly. But, mostly you will see that bull markets rise until the Ratio hits 20 before the bears take over, and the market goes down.
Today, our Ratio is about 16, which means our stock market remains under-valued and has plenty of room to rise, IF the policy-drama in Washington ever ends. Home sales are increasing, home values are increasing, consumer confidence is rising, bank lending is rising! The bulls want to run . . . please let them run, Mr. Obama, Mr. Boehner, Mr. Reid, Mr. McConnell, Ms. Pelosi, et.al.!
