Stock Valuation Using P/E Flawed?

[moda0306]

I was thinking of the options of investors today walking into the market vs in, say, 1993.

In 1993 we had treasury bond rates yielding between 3% and 7.5% on the curve, and along with that all the implications of corporate and muni bond options out there at higher rates as options for investors.

In 2011 we have between 0% and 3.6% on short-to-long-term treasury bonds.

Shouldn't we be willing to accept a much higher P/E ratio given the other options in the market today than in 1993?  Should we be looking at P/E as an implied interest rate, if you will, with which to compare to current bond yields?

I'm sure this has been brought up, but there are seriously very few seemingly "great" deals out there and I wonder if our standarts for P/E should adjust with interest-rate prospects.

[Saluki]

One way of valuing stocks in the broad market is the so called "Fed Model" that does exactly this.

http://en.wikipedia.org/wiki/Fed_model

The basic idea is that the earnings yield (E/P), the inverse of the more commonly used PE ratio, should be roughly equal to the inverse of the yield on government bonds.  By this method, with a 30 Year yield of approximately 3.8%, the correct market PE should be 1/3.8%, or 26.3.  Currently it's around 16-17 from the sources I'm seeing, suggesting that either the market is undervalued or that government bonds are overvalued.

[moda0306]

Looks like it's the 10, not 30 year.

[Saluki]

I've seen 10 year used most commonly, although some use 30 year.  Usually when I saw it discussed, leading earnings were also used. The point was mostly to justify higher stock prices so by using inflated earnings estimates and the shorter bond durations you get a higher estimated value for the market. 

[yellow4yield]

I was watching the stock ticker the other day when everything was dropping so much. Of particular interest was *what* was dropping the most in value!

Mostly well known companies like Disney, IBM, Microsoft, etc. And as I recall, Disney had announced higher than expected earnings that day!

To me this says the "little guys" were selling their stocks. And I would guess they might tend to invest in companies with names they are familiar with?

Add to this the "dumbing down" of Americans, then that is what will give you the future value of stocks - Not any complicated math formula! (me thinks)

And where do these people get their information? The evening news!

So perhaps what the evening news says might be a better predictor of future value?

Or the book: Extraordinary Popular Delusions & the Madness of Crowds