Why is S&P average PE ratio increasing since 1990?

Question

PE ratio is one of the best tools to evaluate equities. A company that has positive earnings will have a positive PE ratio. But what is considered a reasonable PE ratio appears to be changing over time. I usually hear 10 as a very good PE ratio for company with stable earnings. If I was able to buy an entire company with a PE ratio of 10 and simply kept the earnings for myself and it didn't grow or shrink in earnings then after 10 years I would have my original investment back and all earnings after that time would be my gain.

However when I look at https://www.multpl.com/s-p-500-pe-ratio I see that since 1990 the average PE ratio has not dropped below 15 unlike the past. Looking at GDP growth I don't see the United States experiencing more growth in the last 30 years than before so that leads me to conclude that companies in the S&P 500 are experiencing the same earnings growth now as before 1990. So what has changed that justifies the increased price investors are paying for the same earnings and expected earnings growth?

One theory I have is that lifespans are increasing so people are simply willing to wait longer for gains to be realized. If my lifespan is 40 years and I have to wait 40 years for a gain that would be unacceptable but if my lifespan was 80 then a gain after 40 years is reasonable.

Are there any written materials or papers on this subject of increasing PE ratios since 1990?

Answer 1

The inverse of the P/E is the earnings yield, which is somewhat analogous to the interest rate on a bond. Interest rates have been generally falling for the past several decades, sometimes attributed to a "savings glut". Stocks and bonds compete as investments; when bonds' yields fall and prices rise, so often do stocks'. Another viewpoint is that bond yields set the "discount rate" for valuing a stock's expected future earnings, so lower rates translate to higher valuations.

Answer 2

After-tax profit margins were once common at about 5%. Now they are common at 8% to 10%. Corporate earnings did increase.

Something else to look at is the debt-to-equity ratio.

Answer 3

10-yr Treasury Rate image posted from Macrotrends, attribution requested.

The simplest answer is to look at stock yields (i.e. dividends) and see how they compete. If I can get 8-10% in a government guaranteed security ('riskless' if held to maturity, except for inflation), vs, say 2-3% in stocks, with hopes of better returns, but no guarantee. i.e. the return expectation is a bell curve, centered at around 10% but with a 14-15% standard deviation. Shiller's PE10 approach (same web site you linked to, just a different methodology) shows a relatively high 31.31 PE10.

When anyone says 'this time is different', I'd take it as a hint that this Nobel Prize winning author has been proven right in the long run. PE is still a good metric, but has been inflated partially due to interest rates staying low for so long. It's only when rates start to rise that people will realize that markets don't go up forever.