What is the "Normal P/E ratio" that is shown in blue on the graph? How is it different than the P/E ratio? (08/22/2014)
The short answer is that it is a dynamically-calculated trimmed mean of the annual historical P/E ratios. One high and one low P/E are trimmed from the list, before averaging the remaining numbers. If the length of history is 4 years or less, it is simply an average.
Each year’s price earnings ratio (P/E) is used in the calculation, such that different numbers will be calculated for a 5-year graph compared to a 10-year graph, or a 15-year graph, etc. The primary benefit of the normal P/E ratio is to serve as a barometer or measuring device that allows you to visually see what values the market has traditionally applied to a given company over time. In other words, it should not be looked at as an absolute factor, but rather a measuring stick or “tool to think with.”
Also keep in mind that you as a subscriber need to think about what you see on each graph. As an example, draw a 15-year graph on MSFT and SCG.
You will notice with MSFT that the first part of the time MSFT traded above the normal P/E and the last two-thirds of the time it traded below the normal P/E. It is an average over time, such that the steadily decreasing P/E ratios just calculate out to an average which, when drawn as a line, bisects the price line.
You will notice with SCG that the normal P/E line appears to be more useful in that it shows what P/E multiple the market has typically traded SCG. The price for SCG wavers back and forth around the normal P/E.
To summarize, the normal P/E ratio represents a historical valuation measurement or factor at which the market has normally (historically) capitalized earnings. It does not necessarily measure what a company is worth, but rather it is the multiple of earnings with which the market has normally valued the company.