On the basis of Robert Shiller 10-year trailing, inflation-adjusted PE ratio, the market is overvalued today at 24x.

According to BofA/ML strategist David Bianco -- who is profiled in the WSJ -- the valuation measure is flawed (via @ericbradbury).

There are three reasons Bianco doesn't like the Shiller method:

First, he prefers to look at operating earnings, rather than as-reported profits, because the writedowns of the past few years are wildly distorting.

Second, Bianco thinks the relevant comparison should not to back to before the 1960s, since the preceeding period was distorted by two wars and the depression.

Finally, he thinks that since companies retain more of their earnings today -- pay out less in dividends -- they necessarily grow faster.

The following is from a recent not of Bianco's:

Shiller’s PE misrepresents S&P 500 valuation

The current Shiller PE of 24x is 50% above its 1900-2010 average of 16x. While we would normally take concern with a valuation measure 50% above its long- term average, we encourage investors to ignore this one. We believe Shiller’s $55 inflation-adjusted 10yr trailing avg. EPS is not a fair representation of normalized EPS for 2010 and prefer our $90 Equity Time Value Adjusted (ETVA) 10 yr. avg. EPS. The current ETVA PE of 14.7x is almost a multiple point lower than the 50yr

average of 15.6x and is well supportive of our 1400 year-end target.



Shiller's PE understates normalized EPS

Shiller's PE cannot be fairly compared across time because it neglects substantial shifts in dividend payout ratios over the last 110 years. Anytime the dividend payout ratio is not 100% EPS should rise with inflation plus the return on reinvested earnings. This is called an Equity Time Value Adjustment (ETVA). Shiller’s EPS does not fairly represent normal EPS because it assumes EPS only

grows by inflation, which given a decade of high EPS retention, is flawed.

Here's a look at the market vs. the Shiller ratio: