The Stock Market Price Earnings Ratio

The stock market price earnings ratio is a guide to whether the overall stock market is expensive or cheap. It goes to say the stock market price earnings ratio could provide investors with an indicator whether it is a good time to buy stocks or to sell stocks in the stock market.

The stock market price earnings ratio is calculated by taking the total market value of all of the market’s stocks combined and dividing this number by their combined earnings. The calculation is tedious ... and now most online trading platforms have this ratio calculated for you ... just need to look under the Market Summary)

Based on the calculation on 26/3/2015, the current stock market price earnings ratio for Malaysia is 16.12. From past stock market records over the many years, we see the average (or mean) stock market price earnings ratio for Malaysia is around 16. So the stock market could be slightly overvalued at 16.12 although still not too high so as to be worried of a bubble stage.

What the Number Means ?

Here is the explanation behind the meaning of the stock market P/E Ratio for Malaysia :

Overvalued – P/E Ratio above 18

Fair valued – P/E Ratio between 14 to 18

Undervalued – P/E Ratio below 14

However, many people find the stock market price earnings ratio misleading. A case in point is the year 2010 (see the P/E Ratio chart above) where the P/E Ratio was around 18-19 while the KLCI Index is below 1,300 points. And today when the KLCI Index is at 1,800 points the P/E Ratio decreased to 16.12!

This situation could easily happen because during 2010, profits margins and earnings were very low due to the recession causing the P/E Ratio to be higher. A better indicator will be using the Shiller P/E Ratio or simply called the PE10 where the average earnings over 10 years are taken instead of 1 year and they are subsequently adjusted for inflation.

Still, despite some misgivings about the accuracy of stock market price earnings ratio, knowing the KLSE market PE, you can get a feel of the total valuation of the whole market.

Should the PE be high, you will probably not want to put in fresh money into the market and perhaps sell some of the stocks.

Should the PE be low, you will probably not want to cash out from the market together with the herd and perhaps actually put more money into stocks.

Conclusion

We can safely conclude that although the KLCI has gone up substantially breaking a fresh new high in the last 6 years, the market is NOT overvalued using the market PE as a guide. It is at at FAIR valuation, not undervalued but certainly not in the excessively overvalued region, i.e. a bubble situation.