One of the primary reasons for doing the original analysis was to get a feel for the range of multiples that have been applied to stock market earnings in the past 100 years or so. As the table below shows, the range of earnings multiples is very wide; the normalized price earnings ratios, NPEs, range from around 33 to around 7. (Note: NPE is price divided by normalized earnings.) What this means is that there have been years when the market charged ($100 of earnings x an NPE of 33=) $3300 for $100 of stock market earnings; there have been other years when you could buy the same level of earnings for about $700. The range between expensive and cheap is very wide indeed.
Pricing the Dow Using Historic Earnings MultiplesAn important question is, based on our history of earnings multiples since 1900, what price might the stock market have assigned to the Dow given recent earnings. Answering that question will give us some perspective. First, we will look at 2002, and then extrapolate to 2008/2009.
Implications of Price to Earnings Ratios on Expected Dow Price Range for 2002
Note: The average NPE between 1898 and 2007 was 14.9.
The table above approximates the range of prices that the market might have paid for 2002 normalized earnings (NE) of $455. (Because of the way I normalize earnings, 2002 is the most recent year for which I have calculated normalized earnings.) The table shows