While investors continue to worry that Apple makes over 65% of its money from phones, there were a lot of positive signs in latest earnings release, but none bigger than the fact that China saw sales nearly double. There is no guarantee when you buy stock and you should always be prepared to accept losses, if they come, and gains, if you are fortunate and buy good, solid companies. The most common stock market valuation method is the stock Price-to-Earnings Ratio (P/E Ratio). The P/E Ratio for any stock can be determined by dividing a stock’s price by the reported earnings over the past twelve months. For example, if Bank of America (BAC) is selling for $10 per share, and it reported earnings of $0.50 per share during the past year, then BAC’s stock has a P/E Ratio of 20. Investor’s buying and selling decisions ultimately drive up and down the stock market.
For the purposes of avoiding the next stock market crash, when the average P/E Ratio for stocks in the Standard and Poors 500 Index (S&P 500 Index) is above 15, it is time to pay close attention to the stock market news flow and look at other confirming indicators of a stock market top nearing (but not necessarily take any action). When it goes above 18, it is time to examine other confirming stock market top indicators closely, and consider taking action. However, the stock market may still have a long way to run on momentum and irrational exuberance after surpassing the 18 warning level.
For example, in the year 2000 the average S&P 500 Index P/E Ratio went to 30, which was followed by a stock market crash that saw the NASDAQ lose 75% of its value and the S&P 500 Index lose 45% of its value. Investor Sentiment is a reading of how many investors are bearish (think the stock market will decline) versus how many investors are bullish (think the stock market will increase).
For example, during periods of high growth, investors may be willing to buy stocks even when the average stock market P/E Ratio is well above 15, because the earnings growth outlook is so good that they assume the earnings part of the equation will catch up to the price part of the equation. To counter this fault in the average stock market P/E Ratio, investors take a look at the average S&P 500 Index PEG Ratio. The average S&P 500 Index PEG Ratio = Stock Price / Earnings Over The Past Year / Expected Annual Earnings Per Share Growth Rate. This is just a sampling of the many advanced stock market valuation methods that are available for review.
Of course, earnings expectations can be and often are wrong, especially when the economy goes from growth to recession, so it is important to also look at the advanced stock market valuation methods outlined in the following section to get a sense as to whether the risk of a stock market crash is high and defensive moves may be warranted. The following are some advanced stock market valuation methods that should be considered when evaluating whether the stock market is overvalued and whether the potential for a stock market crash is high. The US stock market is levitated by desperate and relentless buying by the Fed.