Price-Earnings Ratio in First Six Months of 2012: 13.8
Since the bottom of the financial crisis in early 2009, U.S. companies have delivered solid earnings growth, quarter after quarter. That growth has come despite modest sales gains as companies have squeezed costs and become leaner. Profit margins are now near pre-crisis highs. Yet there are plenty of reasons to be skeptical about how well American companies can hold up. The U.S. economy is sluggish and unemployment remains high at 8.2 percent. Also weighing down American companies are Europe's worsening crisis and slower economic growth in the U.S. and China, the world's two largest economies.
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Why It Matters
Earnings growth has more than maintained pace with the dramatic rise in stock prices over the past three years. Despite a near-doubling of share prices, the price-earnings ratio of the S&P 500 index has dropped, from 18 to below 14. Price-earnings ratios, a key measure used to gauge whether stocks are good values or overpriced, averaged 13.8 in the first six months of this year -- 16 percent less than the average P-E of 16.4 since 1954. Investors who think the U.S. economy may withstand the broader economic pressures and start rebounding could judge U.S. stocks to be cheap at current valuations.
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What It Means for Your Portfolio
The trend of rising profits amid sluggish sales growth is expected to continue. The consensus estimate among Wall Street analysts is for earnings growth to clock in at 2.5 times that of sales growth in 2013 and 2014. That compares to 1.5 in 2011 and an expected 1.25 in 2012. Earnings growth, along with an attractive price-earnings ratio and extremely low interest rates, could be viewed as a bullish combination by investors. If profit margins keep expanding, stocks could perform quite well, even though the U.S. economy may remain sluggish. If the American economy rebounds and hiring finally picks up, the outlook could be even brighter for U.S. stocks.
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