In Recession, Watch the Stock Ratios: Market Could Be Back Where It Was Just Before the 1987 Crj
Corporate earnings in a typical recession would drop enough to make stock prices as overpriced as they wdre in the summer of 1987.</br></br>Why? It has to do with price-to-earnings ratios, an indicator used to tell whether you're paying too much fof a stock. With lower earnings possible, those ratios could go out of balance quickly.</br></br>Keep that in mind if you venture into the stock market. The bottom line is this: If there is a recession and company profits decline the typical 16 percent to 25 percent, the stock market would be back where it was right before the 1987 crash, with P/E ratios in the low 20s-to-l.</br></br>The stock marketÛªs recent ascent has put P/E ratios at around 16.5-to-1. In 1987, the ratio was about 23-to-l for the 400 companies that make up the Standard & PoorÛªs 400 stock index.</br></br>The P/E ratio for the stock market is a simple calculation derived by dividing the collective prices of companies (in this case the 400 S&P stocks) by the collective eaming9 per share of those companies, The ratio can increase either by the numerator (the stock prices) going up or by the denominator (the earnings) going down.