`The first chart shows the long-term price/earnings ratios and subsequent
10-year real price change; the secpmd shows the record of projections based
on that relation (red line) and the actual course of prices (blue). "Prospective
changes" means forward-looking - the number for 1986 is the real change
in prices from 1986 to 1996. Technical details: For this study, a P/E ratio
has been computed for every year using the real stock price for that year
divided by the average of real earnings per share over the past 10 years.
(All values are yearly averages; stocks are the S&P 500 index and its
predecessors; real values are computed using the PPI.) That P/E is then
compared with the real change in stock prices over the following 10 years.
So 1986's P/E number is the real stock price that year divided by the average
of profits from 1977-86; that number (actually its logarithm) is then compared
statistically to the real change in stock prices from 1986 through 1996
to see if stock prices can be predicted from valuations. That regression
anal ysis yielded a formula that explained almost half of the course real
stock returns (i.e., adjusted r2 = .478; p=.0001). Data begin in 1871 and
end in February 1997; prospective return figures are avail able from 1871
through 1987; forecast returns, from 1880 through 1997. `