Based on the CFA level 2 Curriculum model of fundamentally justified P/E ratio – “price multiples in terms of fundamentals” – I have calculated a current fundamentally justified P/E ratio of S&P 500 index at the level of 15x. Current S&P 500 index trailing P/E ratio is at the level of 23x. In case the history will rhyme again and equity valuations will gradually reverse to its fundamentally justified mean, S&P 500 index could decline by approximately 34% in the mid-term horizon, from the current level of 4766 points to approximately 3200 points. With that being said, within my calculations I have used the current 4.1% yield to maturity of the 10-year US Treasury bond as the risk-free rate, current S&P 500 index ROE of 18%, the expected long-term EPS growth rate (g) of approximately 4% (real GDP growth potential of 2% and Fed’s inflation target of 2%) and Equity Risk Premium (ERP) of approximately 5%.
Fundamentally justified P/E ratios for S&P 500
