Stock Market Valuation Using The P/E Ratio: A Hands-On Exercise

Abstract

Finance professors and media frequently use the P/E ratio of the S&P 500 Index to gauge whether the aggregate stock market is correctly valued at a given point in time. This article presents an assignment that introduces students to the concept of stock market valuation via a hands-on exercise. In particular, it requires students to use an EXCEL template to calculate various versions of the P/E ratio (trailing, forward, operating, and Shillers), gauge whether the stock market is correctly valued, undervalued or overvalued, and then examine the sensitivity of these inferences to using different versions of this ratio. The entire exercise can be implemented using data available in the public domain.