What Is the Long-Term Average PE of the Dow Jones?

by Randolf Saint-Leger

    The price-to-earnings ratio of the Dow Jones Industrial Average Index is the value of the index divided by total earnings of the stocks that make up the index. Even though the index began in 1896, the year 1929 is a commonly used reference point for any long-term average because of the 1929 stock market crash. If you want to know whether the DJIA is under or overvalued, you can compare its current P/E to its average over a specific time horizon such as the last five years.

    The Dow

    The Dow Jones Industrial Average is one of the oldest stock indexes in the world, dating back to 1896. Investors focus on it because it is an indicator of broad stock market sentiment and valuation. The DJIA represents 30 of the largest U.S. companies spread across several sectors with the exception of the Transportation and Utilities sectors. The industrial and technology sectors represent the largest sector allocation of the DJIA at 20.70 percent and 16.94 percent, respectively.

    Long-Term P/E

    The DJIA experiences significant highs and lows due to geopolitical events, economic factors and stock market corrections. There have been extreme periods throughout the DJIA's history that produced unusually high P/E readings. For example, in 1999, during the "dot.com" era, the DJIA reached a high ratio of 44.2 P/E. From 1929 to 2010, the DJIA's average P/E was about 15. This means that investors were willing to pay, on average, $15 for every $1 of earnings of the DJIA over that time span.

    P/E and Valuation

    Investors use P/E ratios to value indexes like the DJIA and individual stocks. If the DJIA has a current P/E of 10 versus a historical average of 15, then you might conclude that the DJIA is undervalued, making the DJIA a good buying opportunity. Conversely, if the DJIA's current P/E is 17, it could mean that the stock market is overvalued, and it's time to sell. For example, the DJIA's high P/E ratios of over 40 in late 1999 and early 2000 should have been a signal of stock market overvaluation. Using P/E ratios to value the DJIA requires that you also research the variables that affect the index, such as employment, inflation, the economic cycle and impact of world events for further evidence that justifies the P/E valuation.

    Forward and Trailing P/E

    Investors like to look ahead rather than at the current P/E ratio to make an investment decision, which is why the forward P/E ratio is important. P/E ratios, and in particular the forward P/E, are a way to ensure that you are not overpaying. The forward P/E is the market price divided by expected earnings per share over the next 12-month period. The trailing P/E is the market price divided by past 12-month EPS. As of August 2012, the forward and forward and trailing P/E for the DJIA was 11.81 and 13.60, respectively.

    Considerations

    While investors consider the DJIA as a market proxy, an even broader index is the S&P 500. The S&P 500 is an index based on the stock prices of 500 top publicly traded U.S. companies. Investors typically use the S&P 500 as the broader representation of the market rather than the DJIA because it represents leading companies in the leading industries. Generally, the S&P and DJIA should produce similar P/E ratios.

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    About the Author

    Randolf Saint-Leger began his professional writing career as a junior research analyst. His writings have appeared in various online publications as well as "First Call," a leading news source for professional fund managers. Saint-Leger holds a Master of Business Administration in finance and international business from Pace University.

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