Price Earnings Value of ASX 200

I came along a set of interesting numbers which I have put into a graph below. These numbers reflect the ASX 200 (which comprises of the top 200 shares on the ASX) price to earnings for the past 5 years.

Looking at the graph you can see that this is in a steady downtrend.

This would suggest to those viewing it that the current bull market run of 3 years is not overextended. If you were viewing this data without knowing how the market has performed you would probably assume the market has dropped or remained steady.

So why has the avg P/E ratio dropped ?

My speculation is the resource boom has caused dramatic increases in some of our major companies such as Woodside Petroleum Ltd (ASX:WPL), BHP Billiton Ltd (ASX:BHP), and Rio Tinto Limited (ASX:RIO). Along with this banks such as National Australia Bank (ASX:NAB), Commonwealth bank (ASX:CBA), Westpac Banking (ASX:WBC) and ANZ Banking (ASX:ANZ) have continued to increase the profits to record levels. The stock market rising has also boost the fees chargeable for financial firms such as AMP Limited (ASX:AMP) and Etrade (ASX:ETR). This flows through to other sectors which support these companies such as IRESS Technologies (ASX:IRE).

Another reason could be that there are a record number of Listed Property Trusts (LPTs) in the ASX 200. This companies historically have lower Price to Earnings ratios and higher dividend yields.

Is the Market Overheated ?

To determine if the market is overheated I started to look at the sector breakdown and found some interesting statistics. Of the ten sectors that make up the index, 70% (7 out of 10) were showing Price to Earning ratios of 20 or more. The average is 16.5 so a ratio of 20 shows that sector is around 20% overpriced. The only three sectors not overpriced were financials, Materials and Telecommunications.

I wrote this article to show that all statistics on the market are not equal. If I broke this down further I would be able to specifically pick out stocks which are over priced in each sector. I would also be able to highlight which companies in each sector are currently showing value and could be a potential takeover target or are set for a turnaround.

So to answer the question on whether the market is overheated : YES !!!!

70 % of the market is running at historically high price to earnings and there is only two ways for this to remedy itself. The first is the prices retract to the historical mean which is around 15-16 for the ASX 200 or companies produce dramatic earnings increases in the future to justify the high price to earnings of today.

Good Luck Investing.