Long-term investors should avoid stocks when the price-to-earnings ratio (PE) is high.
The chart below matches up the rolling S&P 500 PE and the following 10-year returns…
When PE is high, long-term returns go down. This is an inverse relationship and I’ve provided a correlation chart below…
The PE ratio sits at above 22 today and that’s well above its average of 16. The expected 10-year returns are 50% and 106% respectively.
The expected 50% return in ten years is 4.1% annual return (CAGR). You can get that level of return with lower risk elsewhere in the market.
This is compelling evidence to avoid buying stocks for the long haul today. Wait for PE to revert to its mean or drop even further.
Investing is a game of probabilities. By crunching the numbers and pinpointing trends, you can improve your odds and magnitude of success.
Ideas are important but the data to back it up is crucial… PE is just one key indicator of long-term stock market returns.
Note: Returns don’t include dividends so actual returns will be higher across the board.