Considering the changes in how the constituents of the SP500 were selected and the changes to the accounting rules, is there justification or added information for comparing earnings yield from 60 years ago to today.


I don't think either matters.

The stock selection criteria don't matter because the S&P 500 has always been such a huge subset of US corporate operations. Sales, profits, employees, assets, whatever. Large enough that the overall index results correlate almost perfectly with the overall results of US corporations. The actual changes to the inclusion rules are relative quibbles in the grand scheme of things. Perhaps the biggest is that they used to allow non-US-domiciled firms to enter the index, but don't any more (using complicated definitions), since around 2010 I think. There are about 10-15 non-US companies are grandfathered since that change.

As for the earnings being measured differently, this is a very common trope among those pushing "broker economics". (i.e., whatever reasoning makes today a great day to buy stocks from me). Sure, accounting standards have changed. The biggest one by far is that goodwill depreciation isn't mandatory any more. So Olde Timey earnings figures were understatements, meaning older lower P/E ratios would correspond to higher newer P/E ratios. But the difference isn't worth arguing about. Sure, if you bend over backwards and totally ignore the newer impairment-test driven write-offs, you might argue that aggregate earnings today might be 3-5% higher if calculated under the old rules, at least during bull markets. That doesn't change the conclusion at all: valuations are way higher than they used to be. 95%? 85% 75%? who cares?

The biggest valid change in comparability is probably that the mix of firms has changed...many newish/biggish firms aren't nearly as capital intensive as in the past. (at least not until lately!) This has nothing to say about CAPE-style valuation metrics since earnings are earnings, so P/E ratios on that front mean the same thing as ever. But it does argue that a higher price/sales ratio is more justified than the same ratio would have been in the past.

The other big factor is that in recent years, profits as a fraction of GDP have soared, for two main reasons: Lower real interest rates on average in the last 15 years, and lower corporate income tax rates in the last decade. These are both long run mean reverting...clearly aggregate profits will forever be bound to some range as a percentage of GDP. But more importantly, that means that if anything the cyclically adjusted earnings are currently being calculated to be *higher* than they should be if you want to estimate what the forward earnings will be after those cyclical effects end. Meaning any CAPE-style metric is likely underestimating how overvalued US stocks are at the moment, for a long hold. On that front, the market is more expensive than it seems, not less.

None of this suggests that the market will drop a lot any time soon, nor that past average valuation ratios will be the same as future average valuation ratios. But what we can say with absolute certainty is that the valuations are definitely very very much higher than they were in the past, even if you compare to only the last decade or two of historically high valuations.

Jim