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A Dimensionless Number
By Staff Reporters
SPONSOR: http://www.MarcinkoAssociates.com
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What is the Rule of 20?
The Rule of 20 is a dimensionless number that adds the current 12-month trailing Price to Earnings Ratio to the annual change in an index of the annual consumer inflation rate. A reading below 20, while a market is trending lower, means that we could be near a bottom.
In the United States, the most common index used is the broad-based S&P 500, and CPI-U is used as a proxy for inflation.
The Rule of 20 is purportedly a rule from Peter Lynch. In chapter 39 of Graham and Dodd’s seminal Security Analysis, they mention: “We would suggest that about 20 times average earnings is as high a price as can be paid in an investment purchase of a common stock” … with no mention of inflation.
Lynch’s formulation attempts to factor the ‘gravity’ of interest rates into the fair value of a stock. And, as you can see, the measure has fluctuated quite a bit. However, it has returned to roughly the 20 level repeatedly.
MORE: https://dqydj.com/sp-500-rule-of-20-calculator/
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Filed under: "Ask-an-Advisor", Experts Invited, Financial Planning, Funding Basics, Glossary Terms, iMBA, Inc., Investing, Touring with Marcinko | Tagged: CPI, CPI-U, economics, economy, fair value, finance, Graham and Dodd, inflation, inflation rate, Marcinko, PE ratio, Peter Lynch, rule 20, S&P 500 |
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