You may be asking yourself why I focus so much on P/E ratios in my analysis of the U.S. stock market. Certainly there are other factors that should also matter for investors. But I think this is one of the most important ones because it gives a sense for how the stock market price reflects the fundamental value of what you are buying.

You’ve got to ask yourself what it is you own when you buy a share of company stock. Owning a share of stock entitles you to a variety of rights as a company shareholder (see the Wikipedia on Stocks for an overview). But at the end of the day, owning one share of stock entitles you, directly or indirectly, to one share of future company earnings.

Stocks are worth only as much as people are willing to pay for them. In good times, people are willing to pay a lot (sometimes too much) for a share of the stock market. In bad times, buyers are scarce and prices can drop very quickly. As an investor, I’d like to own something that has *fundamental value* over time, even if nobody else wants to buy it. A portion of future company earnings, while uncertain, has fundamental value. Even if nobody was willing to buy my Google stock from me, I would at least be entitled to a portion of all of Google’s future profits.

The same holds for real estate. Property is worth only as much as other people are willing to pay for it. But ownership also entitles you to a future stream of rents that you can collect from the property. I’d rather buy property at prices where I would be happy holding the real estate investment for 10 years or more.

When the stock market is backed up by solid company earnings, there is a limit to how far the stock market can fall.  But if psychology turns sour in today’s market, then watch out below.