Look, I can go on all day about AMC Entertainment (NYSE:AMC), BlackBerry (NYSE:BB), Express (NYSE:EXPR), and other meme stocks. But I won’t. I’ve been trading them actively over the last few days. It’s been great. But the problem here is that the market is so detached from reality. I had a friend today tell me that he is looking to do the “dumbest things possible” with his money.
He said it in jest, but I know what he means. People are loading up on stocks that should be bankrupt right now. AMC Entertainment continues to surge despite the fact that all of its competition has received multiple downgrades. AMC has also received lots of downgrades.
Hey, I’m all for exploiting the market and its participants. But eventually, fundamentals DO return to the market. And you don’t want to be the last person without a chair when the music stops. Which is why I stopped to look at an important number…
The P/E Ratio of the S&P 500
Remember, a P/E ratio is a critical fundamental metric. It is the measurement of a company’s stock price divided by the firm’s annual earnings per share. This will tell you HOW many years it takes the average investor to earn back their principal from their investment. So, if I own stock in a company that trades at $200 per share, and it makes profits of $25 per share each year, it will take me eight years to get back that $200 investment.
But look at this figure. Today, the S&P 500 P/E ratio is 44.73. That means it will take more than 44 years to make that initial investment back on this index based on the combined earnings of the companies on it. This is the highest level since the dot-com bubble. And it’s much higher than any point before 2000. In fact, this chart offers a historical analysis of the S&P 500 Price-to-earnings ratio.
This is the measurement of the S&P 500 P/E ratio against its historical mean. It is 88% higher than its historical mean, the highest, again, since the dot-com bubble.
If you’re a statistician, you know that this 88% level is two standard deviations from the historical mean, putting us in very unusual territory. My concern is that what goes up must come down.
I would not be surprised if you see some warnings about this from several financial institutions in the weeks. We’ll talk about how to take advantage of this concern and how to protect your profits and your principal in the days ahead.