**AlphaNinja**- Sorry, but I can't let this die. Earlier today I posted a link to

**FT Alphaville**in which a Mr. Hume suggests that the S&P500 index is trading at 130 times earnings. It is about 900% off the mark. No, I'm not exagerating - the S&P's actual P/E (price-to-earnings) ratio is about 13-14, so that FT Alphaville estimate (not even his own) is 900% higher.

I really couldn't care less about this, if it weren't for the fact that this flawed analysis is so rampant. SO rampant, in fact, that S&P doesn't even understand it.

**In simple terms, this illogical analysis can lead people to think the stock market is more expensive than it really is.**

Back on February 25th, Jeremy Siegel argued in the

**Wall Street Journal**that S&P was miscalculating the underlying earnings of the S&P500, maybe the most closely-tracked (by sheer dollars) market index in the world:

*"A simple example can illustrate S&P's error. Suppose on a given day the only price changes in the S&P 500 are that the largest stock, Exxon-Mobil, rose 10% in price and the smallest stock, Jones Apparel Group, fell 10%. Would S&P report that the S&P 500 was unchanged that day? Of course not. Exxon-Mobil has a market weight of over 5% in the S&P 500, while the weight of Jones Apparel is less than .04%, so that the return on Exxon-Mobil is weighted 1,381 times the return on Jones Apparel. In fact, a 10% rise in Exxon-Mobil's price would boost the S&P 500 by 4.64 index points, while the same fall in Jones Apparel would have no impact since the change is far less than the one-hundredth of one point to which the index is routinely rounded.*

*"*

What is so amazingly inexplicable is that they weight the moves in the index (a 1% move in top-weighted ExxonMobil boosts the index more than the same 1% move in lowly Gannett), while simply aggregating the earnings numbers. S&P actually DEFENDED themselves, and still has the letter on their site:

Below is a look at the top ten and bottom ten weighted stocks in the S&P500, and their trailing 12month earnings. I mentioned Gannett earlier for a reason - they lost $6.8billion dollars in the trailing 12month period. Using S&P's methodology, that would more than wipe out Apple's $5billion profit contribution to the index -> the end result that the "E" in the Price/Earnings equation declines, so the P/E must be higher, i.e the market is more expensive.

This is where the weights come in. If you put $10,000 into the S&P 500 tomorrow, you'll have $150 tied up in Apple stock, because it is 1.51% of the index. Gannett makes up .01% of the index (one hundredth of a percent), so you will have $1.00 tied up in Gannett. You wouldn't even CARE what happens to Gannett stock, but S&P's calculation let's it wipe out all of Apple's profit contribution, thereby making the market look more expensive.

Pretend that your entire portfolio consisted of $9,999 in Apple stock, and $1.00 of Gannett. Also suppose Gannett's P/E was 200, because earnings slipped almost to zero, and Apple's was 20. If someone were to inquire about the PE ratio of your stock portfolio, would you average the two and say "Oh, it's a PE of 110"? Of course not - you'd say, "well the entire thing is Apple, so the PE is about 20." S&P basically does the former.

Apparently the 130 P/E came from a Barrons' table. S&P's own site shows the index trading at a PE of 60, versus a norm of 20. If that's the case, S&P must believe that the index is overvalued and should instead trade at a PE closer to 20, (taking the index down to 316 from the current 950) -> down 67% from here? Total nonsense.

great stuff. thanks.

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