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follow AD 2014 Feb 1, 12:17pm
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If the historic profit margin is 7%, then that means if the profit margin decreases 11% to 7% (and an equal drop in earnings), then the P/E ratio goes up from 19 to about 25.8. Or the P/E may remain at 19 if the S&P 500 goes down about 36%.
"To that point, the S&P 500 surged 30% to record highs last year, while corporate profits only climbed 11% on aggregate."
If profits go up by 7% and stock prices remain the same wont that refuse the PE ratios?
I am talking about profit margin. So if revenue or sales is X, and profit margin is 7%, then the earnings is 0.07 multiplied by X.
Profit margins averaged 11% last year. If they decrease in 2014 to the historic average of 7%, and assuming no change in revenue or sales, then the earnings would drop 36% since the profit margin drop by 4%, that is 4 divided by 11, and multiplied by 100%. If earnings (E) drop by 36% and the P/E ratio remains at 19, then the stock market price (P) will decrease by 36%.
Look at how revenue or sales per share is increasing relative to the price of a share. See the Price to Sales ratio:
There has not been a major growth in the economy to show major increase in sales or revenue. The stock market has benefited mostly from cost cutting (i.e., increase profit on backs of the employees) and Federal Reserve policies (i.e., low interest rates to refinance debt, etc.).