Is the Stock Market Cheap?

In times of critical importance, the conventional P/E ratio often lags the index to the point of being useless as a value indicator. "Why the lag?" you may wonder. "How can the P/E be at a record high after the price has fallen so far?" The explanation is simple. Earnings fell faster than price. In fact, the negative earnings of Q4 is something that has never happened before in the history of the S&P Composite.

The P/E10 Ratio

Legendary economist and value investor Benjamin Graham noticed the same bizarre P/E behavior during the Roaring Twenties and subsequent market crash. Graham collaborated with David Dodd to devise a more accurate way to calculate the market's value, which they discussed in their 1934 classic book, Security Analysis. They attributed the illogical P/E ratios to temporary and sometimes extreme fluctuations in the business cycle. Their solution was to divide the price by the 10-year average of earnings, which we'll call the P/E10. In recent years, Yale professor Robert Shiller, the author of Irrational Exuberance, has reintroduced the P/E10 to a wider audience of investors.

Is the Stock Market Cheap?



April 3, 2009 revised April 6th


An old-fashioned way to answer this question is to look at the historic Price-to-Earnings (P/E) ratio using reported earnings (as opposed to earnings estimates).


The "price" part of the P/E calculation is available in real time on TV and the Internet. The "earnings" part, however, is more difficult to find. The authoritative source is the Standard & Poor's website, where the latest earnings are posted on the earnings page in a linked Excel file (see column D). More...

Using PE as a Guide

http://samltt88.blogspot.com/2008/12/v-thats-y-d-chinese-said-d-length-of.html

Sam, I am a silent reader of seng's blog & also your blog , I found that they are confuse with which PE to use for shares picking, mind to teach us which one to be used?

thanks in advance

Read the below:

random: and which PE should we use bb? TTM PE? Last year's PE? Forward PE? 10 Dec 07, 10:46

sasuka: andy.. I doubt syndicate will play the market... so just look at good timing 2 enter... 10 Dec 07, 10:46

random: even the PE stated on my HLE screen is sometimes wrong.. 10 Dec 07, 10:45

bullbear: For example, the simple PE. PE of KNM is quoted at around 27 in the Star, in the Financial edge it is 47. The price is the same, so the calculation of PE was definitely based on different EPS used by these 2 sites. This can be confusing for the average investors.

***First of all, who is seng ? Which blog u r referring to?

From d above posting, I can see some of them don’t 100% understand what is PE?

That's y Chinese said: - d length of our fingers r not d same, means: - why some one can be Doctor, lawyer, successful investor n bizman...N why some cant???

Why some can be rich n some r so poor?

Why same effort n guidance given by u but not all of them can be graduate?

As known to u , everyone know who is Warren Buffet N Benjamin Graham, n most of them read their investment skill n method also, why some can be so successful n some r so broke ?

Bcos:-D Length of our fingers r not d same! Some r smart some r not!

U know d formula of PE doesn’t mean u know what is PE!

U know what is PE doesn’t mean u understand what is PE!

U understand what is PE doesn’t mean u know how to apply it on share investment!

Why should u follow d press n broking hse’s PE when they r not d same? (this show they r either don’t understand or may be don’t know how to calculate PE )

Do it yrself by calculate its PE based on its earning lah ! what so difficult ?

Why there r differences of PE ? simple ! Some broking hse calculate based on last year earning, some calculate based on 1 or 2 or 3 qtrs earning !

of course they r different lah !

So which one to use ?

Last year PE take it as a guide, use current earning to estimate its PE for d coming year !

Example :

Last year PE giving u 8

If I see its Qtr earning improving ( minus out d one off earning if there any ) n its future earning looks bright ( Steel sector n oil sector ) , I am quite sure d PE for d coming year will definitely better or lower than last year ^V^

Masteel at 1.51

Based on last year earning of 22.47

PE = 1.51/22.47 = 6.7

Based current earning (3 Qtrs only )= 23.32 cts

PE = 1.51/23.32 = 6.4

BUT dont forget, PE 6.4 is based on 3 QTRS only !!

there is one more to come , therefore , we can expect lower n better PE for Masteel in year ended 2007 !

What is so difficult to get its PE yrself ?D

Do u know how to define mkt crash like 1997 n 1998 ? Mkt crash is when u can buy d below blue chips at PE < 10 :-

PBB , PPB, Maybank, IOIcorp, YTL, Genting , Digi ,SD , IJM , KNM ,Resorts.....

Once u can get d above blue chips at below PE 10, then u will understand better what actually PE is !?

Is low PE guaranteed u sure gain ? refer to my previous posting at :-

http://samgang.blogspot.com/2007/12/v-portfolio-as-at-30-nov-07-v.html


Posted by Samgoss at 7:54 PM


Comment:

Copied an old posting from the above blog to illustrate how PE is being used by this blogger. It is good of Samgoss to share this.

PE is only one of many market metrics one look at as a guide to investing in shares.

Also read:
Market metrics P/E and Intrinsic value

Market metrics P/E and Intrinsic value

DOING LITTLE WITH MARKET PRICE

The most-quoted metric in discussing common stocks is their ratio of price-to-earnings (P/E). This states the relationship between what a stock costs and what benefit it produces.

Many people wrongly believe that value investing involves finding companies boasting low P/E multiples, but:

• not all low P/E stocks are good investments, and
• not all high P/E stocks are bad investments.
• Nor do value investors consider the P/E ratio as an insightful measure for valuation purposes, though it might be useful as a check against overpaying.

The P/E ratio can be used as a screen.

Graham avoided buying stocks unless they were priced at their lowest P/E level during the prior five years.

He also required an earnings-return compared to price (current earnings divided by price = earnings yield) at least twice that prevailing on high-grade corporate bonds.

Other value investors follow these practices. The devices protect against the whims of the marketplace. The market might not be right, but this approach limits the value investor’s exposure from it being wrong.

Value investors resist the temptation to use P/E ratios as supplements to a traditional valuation analysis. This contrasts with devotees of pure DCF analysis in valuation exercises.

When the latter’s results show a wide range of plausible valuations, they often appeal to the P/E ratios of comparable companies as a way to narrow the range.

The approach compares the price of comparable companies to their respective cash flows (P/CF). Suppose a comparable company’s P/CF ratio is 10 (suppose a price of 20 and cash flows of 2). That ratio of 10 is then applied to the subject company. Say its cash flows are 3. Its implied comparables-based value is 30. How much this helps is uncertain. The effort relies entirely on the quality of market pricing for the comparable company. While many finance professionals employ the technique, most value investors do not consider it useful.

Value investors consider the income statement and the balance sheet as sources of information concerning business value. These are superior to market-oriented tools such as the P/E ratio for two reasons.

• First, return on equity captures the full accounting picture, including debt and equity, whereas P/E severs earnings from the balance sheet.
• Second, return on equity is an intrinsic or internal valuation methodology, whereas P/E ratios are products of market or external or valuation processes.

Market metrics (P/E) tell value investors more about Graham’s Mr. Market than about intrinsic value.

Also read:

1. Stock Market Prices
2. Market metrics P/E and Intrinsic value
3. Rational Thinking about Irrational Pricing
4. The Anxiety of Selling
5. Control Value of Majority Interest