From: floydb@rpi.edu
Subject: Re: OK, what about THIS strategy?
Date: Fri, 8 Jan 1993 20:40:15 GMT

In article <1ikgpnINNgvs@usenet.INS.CWRU.Edu> jxs18@po.CWRU.Edu (Jerry Sy) writes:
>
>In a previous article, mike@drseus.jsc.nasa.gov (Mike Ross) says:
>
>>I took a management course wherein a guest lecturer spoke about
>>finances and stocks.  Pressed for some investing advice (not
>>necessarily expected of this lecturer, but she relented), she
>>told us her old boss had gotten quite wealthy with a simple
>>strategy:  each August (I don't know the significance of August)
>>he would buy stocks with a low PE ratio (4 or less), and sell those
>>whose PE ratio had grown out of that range over the previous year.
>>He supposedly only did this once each year.
>>
>>Has anyone heard of or tried this method?
>>
>>NO, oddly enough, I don't remember anyone asking her if SHE used this
>>scheme.  And NO, I'm not an expert investor, so if I just gave the
>>equivalent of 'buy low, sell high', forgive me.
>>
>>-mike
>>
>>
>from what I have read, P/E ratio itself means nothing.  A company's
>stock price could be falling, hence reducing its P/E ratio, and
>buying that stock can make you lose money, if the principal continues
>to drop.
>
>


P/E (Price/Earnings) ratios are supposedly valuable in judging the 
investing population's expectations about the future performance of
any given company. A low ratio may be obtained from either a low price
or relatively high earnings, or both. Thus, investors who bid up the
price of a stock are effectively reducing the P/E ratio until such time
as earnings increase (which is their expectation).

It is said that P/E ratios reasonable for one industry group are not
necessarily reasonable for another. For example, as an industry electronics
firms and software companies are seen as "growth companies", wherein one
expects earning to grow faster than most other industries and/or companies.
P/E ratios above 25 (or 50) are not rare. On the other hand, utilities
and banking companies (on average) "command" a lower P/E ratio (less than 20)
as they are not expected to grow as much. They may be valued more for their
distributions (dividends).

Combining the P/E ratio with information about stock price history and
earnings history you might be able to find "undervalued" companies (i.e.
those with apparently low stock prices given their earnings). Of course,
the investors bidding for that stock feel that the price is fair, otherwise
the price would be bid higher. Over the short term though those investors
may be over reacting to recent news or earnings might have temporarily
risen (lower price or higher earnings, respectively, lowering the ratio).

In the longer term (a year, three years, etc.) the stock and the company
may improve in price and earnings, maybe going from a below industry 
average P/E of 4 to a slight above industry average (depending on the
industry). Historically, the broad market averages have seen P/E ratios
around 10 to 17. Recently, many P/E ratios have averaged above 20 or 25.
Many say that the "market is overvalued, dangerously so...". Translated,
the analyst doesn't expect earnings to meet investors expectations
(judging from inflate prices). However, the P/E ratios could come down
sharply if earning surge. You can calculate the percentage increase in
earnings required to lower a P/E from 20 to 10 or any other average.

barry
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