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.
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