So it's a way to average the PEs appropriately by averaging their reciprocals, i.e. their Earnings Yield. That way everything stays in "PE space" so it makes conceptual sense to us.

A more meaningful way to express this is that the PE average (as harmonic mean) is simply an average of all the earnings yields. The final average earnings yield is then concerted back the PE ratio by as usual inverting it.

This very similar to the method I proposed (the sum of market caps divided by simply summing all the actual earnings) except that my method accounts for the companies having different sizes. A company with meager earnings (positive or negative) would effect the average much less than a large company with huge earnings (or losses).

The harmonic mean approach gives equal weighting to each company in the index (as is just averaging the yields).

The key insight is that for an equal weight used the results would he very similar.

I’m consequently very happy with the harmonic mean approach specifically when applied to an equal weighted index. For a market cap weighted index you would need to use the method I proposed.

I wanted to check this because the forward PE of the Software and Services ETF (XDE) is reported as 28 (stated as using harmonic mean) which is in my view not too expensive, given how rapidly these firms are growing on trend.

- Manlobbi

Index Investing FAQ

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