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Even With Slumping Earnings, This Market Looks Cheap

I am a bit bearish in the near term, since we are indeed proving to be at the center of the worst earnings season since 2009. The earnings trouble spans all corners of the economy, with Alcoa (NYSE:AA) starting off the Q3 earnings show with a growth warning, belwether UPS (NYSE:UPS) posting slumping profits and tech giant Google (NASDAQ:GOOG) shaking things up with a dramatic (and ill-timed) earnings miss.

Even growth darlings like Apple (NASDAQ:AAPL) are starting to stumble after a strong run so far in 2012, sparking fears that the big run year-to-date is about to crash to a halt.

However, it’s worth noting that despite the lower profits and missed expectations at some big-name stocks, this market is actually cheap on price-to-earnings basis.

Remarkably cheap — and if you know where to look, ripe with bargain buys.

Horan Capital Advisors breaks down the current P/E picture and shows that valuations are the most reasonable for equities since the 1990s … with a pretty compelling chart to tell the story.

Here’s their take: Though P/E ratios have moved slightly higher in the near term — most likely due to the obvious combination of rising stock prices and slowing earnings — the market is still pretty cheap in the wake of the financial crisis.

S&P 500 -- P/E Ratio

In their own words:

“From 1900 into the mid-1990s, the PE ratio tended to peak in the low to mid-20s (red line) and trough somewhere around seven (green line). The price investors were willing to pay for a dollar of earnings increased during the dot-com boom (late 1990s), surged even higher during the dot-com bust (early 2000s), and spiked to extraordinary levels during the financial crisis (late 2000s). Since the early 2000s, the PE ratio has been trending lower with the very significant but relatively brief exception that was the financial crisis. More recently, the PE ratio has moved slightly higher. It is worth noting, however, that even with this recent uptick, the PE ratio still remains at a level not often seen since 1990.”

In short, earnings may be slowing down, but the past few years may not have been truly priced into equities yet. On a P/E basis, the market is looking pretty affordable compared to historical levels.

Of course, in the 1980s and 1950s the market slipped soundly below a P/E of 10 thanks to big-time macroeconomic and geopolitical concerns.

So just because the market is “cheap” now, that may not mean it’s time to buy stocks.

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Jeff Reeves is the editor of and the author of “The Frugal Investor’s Guide to Finding Great Stocks.” Write him at or follow him on Twitter via @JeffReevesIP. As of this writing, he owned a long position in Apple but no other stocks named here.

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