Should an ideal Price/Earning ration by small?

Question

And how small should it be?

Answer 1

You mean, like, in an "ideal" world? Perhaps, if the stock market were logical and rational, but it is driven by human emotion: fear, greed, hope.

You can only wish it were so easy as to be ideal; dream on.

This would be akin to saying "If a stock declines in price by half, then it is a better value." Actually, some people think if price declines at all, it has better value; discount, a Sale.

If the biggest oil company in the world was a good value at $45, Enron, then it must be a Buy at $20, right? How about $10. Wall Street was recommending this stock all the way down to $5. And the SEC approved all of their quarterly reports. WorldCom was no different. And all of the dot-coms in 2000 was the same story. People bought these stocks all the way down to almost nothing.

I have a rule about buying based on the p/e ratio -- don't do it.

Answer 2

Other things being equal, yes, the smaller the pe the better the bargain. The problem is that there are a lot of variables that go into determining the pe of a stock. Back in 1975 with inflation running at 14%, the average pe of a stock was about 6. Some were 3 and 4. The investment community thought things were hopeless and with good reason.

A factor used today frequently is the PEG ratio, the pe divided by the expected growth rate. What that attempt to do is normalize the pe ratio to the expected growth of the company. PEG ratios under 1.0 are considered ideal. PEG ratios above 2.00 are considered very poor bargains. The big problem is determining what the expected growth of a company is likely to be. It is a very ify proposition. Currently the PEG ratios of oil well drillers are hovering about 0.5. It is obvious to me that virtually no one believes the projected growth rates of these companies as forecast by the security analysts.

Some stocks in some industry groups have elevated pe ratios and I might add elevated PEG ratios. Other stocks do not have pe ratios because they do not have any earnings. And some companies sell not on the basis of earning and pe but on value of assets, such as gold mining companies for example and closed end funds.

Examples of companies in industries with elevated pe ratios are solid consumer goods companies such as General Mills and Procter and Gamble. Both are considered rock solid companies that are expected to do well in both up markets and down markets. They command exceptionally high pe ratios in relation to their prospects.

Bank stocks on the other hand command exceptionally low pe, many hovering around 10. They are in general considered slow or no growth stocks, especially the larger banks despite the fact that they pay good dividends and have consistant earnings and consistant growth.

Answer 3

That depends on the industry the company is in that you are looking at. Ideally a p/e on a company between 5-14 is considered a bargain - but looking at a p/e alone is not enough. Do your homework and find out why a company's p/e is as low as it is.

Answer 4

1

Answer 5

you've got to watch out for cyclical names that have their peak earnings and the p/e compresses to levels where you think they would be cheap, using a p/e rule. if you're interested in learning more about low p/e, low p/cf, high dividend yield, etc. you should check out "Contrarian Investment Strategies" by David Dreman.