Current stock market valuation is at historically lofty levels by just about any metric (excluding analyst forecast earnings for next year, which we will return to in another study).  Wall Street analysts will tend to use short term earnings projections (typically rosy) and extrapolate them into the indefinite future when determining equity valuations to be published to the public, when the market is at peaks.  Conversely, when the market is making bottoms, the analysts nearly uniformly deride the expensiveness of the market.  A good example of the latter was 2002 when analysts used current earnings of $28 per share of the S&P 500 to claim the market was 32X earnings and extremely rich, while currently they use the $79 per share and claim that at 17X earnings the market is cheap.  However, as Ben Graham suggests in The Intelligent Investor, analysts should use the 10-year inflation adjusted earnings in determining valuations.  The 2002 metric would have been 18.4X, while today the market is 23.5X.

An investor can gauge his/her future return prospects by looking at the yield implied by the price at the earnings and dividends.  The measure we are using is the total yield, which is the average of the last ten years of inflation adjusted retained earnings plus the dividend yield.  An investor should expect to receive annual compound total return somewhere near the implied yield.  For example an investor who purchased the S&P 500 in 1982 could have expected a return of 15% annually.  As of month-end 2006, that investor received 14% per annum in dividend re-invested total return.  Now the investor who purchased the index in 2000 could expect a 3% annual total return.  So far that return has been 1.5% annually, with reinvested dividends.  The current total yield is just over 4%.  These are nominal returns.  At the moment T-bills offer just over 5%. 

Much of the return to stocks over the past 20 years has come from the benefits of the return to price stability.  Inflation rates have fallen from 12%+ in the late 70s & early 80s to around 2.5%.  That is the sweet spot. This depresses discount factors, thus elevating stock prices.

There are many questions about how legitimate earnings are, with options backdating, dilution and buy backs, "one time" item exclusions, and other shenanigans.  There is one certain way to judge whether a company is making the earnings that it claims; regular cash dividends.

Favorable periods in which to buy stocks are when yields are generally high, and dividend yields make up a large portion of the yield.  The current dividend yield on the S&P 500 is less than 2%.