Rule of 20: Is the Tide Changing for Investors?
The Rule of 20 provides an easy framework for valuing the stock market (determining the appropriate P/E ratio for the market). The Rule of 20 states, in a normal market, the 12-month forward P/E of the S&P 500® Index should closely mirror the number 20 minus the yield on a 10-year Treasury bond. When the forward P/E of the market is less than the Rule of 20, the market is considered to be undervalued. Conversely, when the forward P/E is greater than the Rule of 20, the market is considered to be overvalued. The Rule of 20 isn’t the only way of looking at stock market valuation, but it is a good, common sense way to value the market.
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