But stocks are priced at “p/e multiples” – that is, multiples of next year’s earnings. Why? Because presumably they won’t earn profits for just one year; they’ll go on making money for many more. When you buy a stock, you buy a share of the company’s earnings every year into the future. The price of the S&P 500 has averaged roughly 16 times earnings in the post-World War II period. This is typically described as meaning “you’re paying for 16 years of earnings.” It’s actually more than that, though, because the process of discounting makes $1 of profit in the future worth less than $1 today. The current value of a company is the discounted present value of its future earnings, so a p/e ratio of 16 means you’re paying for more than 20 years of earnings (depending on the interest rate at which future earnings are discounted).

In bubbles, hot stocks sell for considerably more than 16 times earnings. Remember the 60 to 90 times for the Nifty Fifty! Investors in 1969 were paying for companies’ earnings – even after giving them credit for significant earnings growth – many decades into the future. Did they do so consciously and analytically? Not that I recall. Investors thought of a p/e ratio as just a number . . . if they thought about it at all.


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