Back to the Bubble: Why P/E Matters for the Dow

Here's a novel notion: If the accounting is honest (a huge if), there is only one price for the stock market: the price-to-earnings ratio. No number like 10,460 for the Dow Jones Industrial Average or 2025 for the Nasdaq Composite means anything apart from the earnings denominator under that numerator. The price of a stock -- just like the price of a bond or a money-market fund -- is not a number plucked from a wire, but a ratio. How much are you paying for the earnings you get by owning a stock?

By that simple measure, the amazing thing about today's stock market is not how low it has fallen, but how incredibly high it is. One year ago, the average P/E of the stocks in the Dow was roughly 20. That is, you paid a dollar for a nickel's worth of earnings. Even in times of prosperity until the mid- and late-1990s, a standard P/E ratio was in the middle or low teens. By the peak of the bubble in 1999, it was in the mid- to higher-20s.

New Economy Nosedive

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