Back in the late 80’s, early 90’s investment clubs were all the rage. Members met in libraries, homes and free meeting rooms all across the country. I joined the National Association of Investors (NAIC), got a few friends together, ordered all their materials and began to study like mad for a few years. The basic tenets set-out in simplistic steps were: 1) invest regularly, every month 2) Buy and Hold and 3) pay attention to the Price to Earnings Ration (P/E) – buy because the price of the stock compared to the earnings per share was reasonable – meaning the stock was not overpriced for the earnings per share it produced. Remembering how important the PE Ratio was back then, it seems it is not seriously regarded so today, perhaps because books are cooked, estimates are tweaked, and like Obama’s jobs reports, we can expect adjustments downwards a few months after the fact.
The NAIC study went much farther than those steps, but those three were the core of the strategy. The price-to-earnings ratio (P/E ratio) was the first indicator we looked at and the measurement that kept our interest going or ended it stone cold. We looked for a P/E of 15, meaning if we maintained that P/E, we would double our money every five years.
On the NAIC website today, I see that clubs are buying, among others, Microsoft, which is showing a price-to-earnings ratio for the trailing twelve months of 14.75. This isn’t about analyzing Microsoft, and I have no idea whether it is a good buy or not, so moving on…
Look at this chart and the comment from Jack Bogle published at Business Insider:
It appears PE ratios are coming down to healthier levels, although you can see a bit of a trend upward.
Doug Ross has a fascinating chart on his site (which began the reminiscing of my years with NAIC). Take a look at this chart reflecting the 10-year average inflation-adjusted PE ratio, known as the PE10 for the S&P, not the Dow (note that it goes out to 2009):
PE10 is the stock index price divided by the average real earnings from the previous 10 years – the time period is designed to smooth out near-term noise in the data. The basis for this approach is the finding that earnings valuation ratios provide predictive power for long-term stock market returns.
Regarding the chart at Doug’s, Above the Market has this comment:
In January 1921, PE10 was 5.12, the lowest value of any January in the historical period. Meanwhile, PE10 in January 2000 was 43.77, the highest January level in history. It is 22.19 today, suggesting that stocks remain significantly overvalued. Historical S&P 500 PE10 is charted below.
To further explain the Price to Earnings Ratio, rather than using the price and earnings for the past 12 months, you can use future estimates for the next 3 or 4 quarters from the company’s own predictions – if you’re brave enough to do so. At one time, blue chips were expected to meet or beat their predictions for the coming quarter, and it was a big oops if earnings dropped below published estimates, but today – well, the stock price may take a hit, but investors are in and out of the market, and in my opinion the PE ratio doesn’t hold the weight it did “back in the day.” It probably should.
Definition of ‘Price-Earnings Ratio – P/E Ratio’
A valuation ratio of a company’s current share price compared to its per-share earnings.
Market Value per Share divided by Earnings per Share (EPS)
For example, if a company is currently trading at $43 a share and earnings over the last 12 months were $1.95 per share, the P/E ratio for the stock would be 22.05 ($43/$1.95).
EPS is usually from the last four quarters (trailing P/E), but sometimes it can be taken from the estimates of earnings expected in the next four quarters (projected or forward P/E). A third variation uses the sum of the last two actual quarters and the estimates of the next two quarters.
Also sometimes known as “price multiple” or “earnings multiple”. Source: Investopedia
Hubby and I watch the stock market daily. He walks by my office twice a day with the up or down escalator report. If you are still in the market, how important is the PE Ratio to you?
Then to get my New Year start, I found this from ZeroHedge January 1, 2013 – (there’s much more in the article than just this snippet, I encourage you to read the entire piece):
Meanwhile, the debt ceiling has already been breached, and the Obama administration is scurrying to seize federal pensions as a temporary fix.
Seriously, how long will it be before they start seizing private pensions, IRAs, etc.? How long before mutual funds and banks are required to hold a percentage of their assets in the ‘safety and security’ of US Treasuries? How long until everyone is involuntarily financing Uncle Sam?
The ZeroHedge article offers some suggestions to avoid “involuntarily financing Uncle Sam.” My investments are no longer in equities, but obviously, I’m affected by the ups and downs, and wonder how it is possible for the average person to save for their future when there are so few avenues to grow your money, as the dollar grows weaker, “real” inflation is not reported, equities are scary, bonds pay little and Social Security will soon be bankrupt? Any ideas?
Let’s end with this jaw-dropping Job Losses in Post WWII Recessions chart from Business Insider:
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