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Using NIPA profits to calculate PE ratios




This post expands on the previous post. The chart above uses the normalized value of the S&P 500 index as the "P" and after-tax corporate profits from the National Income and Products Accounts as the "E", in order to calculate a PE ratio. In the previous post, I was examining equity valuations using a combination of profits, current equity prices, and interest rates. In this post, I leave out interest rates; that makes the degree of undervaluation much less, but it ends up telling the same story. Note that this very simple model of equity valuation correctly identified how cheap stocks were throughout the 1980-1998 period, and correctly flagged the grievous overvaluation of stocks in 2000.

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