What is your view of one of the more popular tools associated with relative ratio analysis, the price to earnings ratio?
The P/E valuation tools is a great way to screen stocks. It is not perfect, but is easy to understand and apply. The investor will have to knowledge of the current market's P/E ratio and that of the sector that the stock in question resides in. No one tool for valuation is full proof, but the P/E tool is extremely easy to apply and can be done in ones head - which is valuable for quick analysis and potential decision making. Just like any tool, it is to used by the investor to aid in getting the job done and not as holy grail.
Do you think the measure of P/E is a valuable tool for stock analysis? Explain and justify your response.
As stated above, it is valuable tool for the investor. Quick and easy to apply is the power of this tool. The danger is solely relying on this tool as a catch all and the holy grail. The intent of tools is not to be this, but to aid the investor in finding their way through a maze - which direction should they go.
Are the current markets under, fairly, or over priced?
http://home.businesswire.com/portal/site/google/index.jsp?ndmViewId=news_view&newsId=20070927005589&newsLang=en
This article suggests the market may be under to fairly priced, but there are several discussions in this article that suggest otherwise. It appears that maybe only a few select sectors fit this criteria and not the market as a whole.
The current market, in my opinion, is probably fairly to over-priced – depending on the sector and specific stock. P/Es are creeping up again and this is potentially dangerous sign. Many P/Es are greater than 15 and mainly close to 20. As the market valuation gets back to more basic fundamentals, the market is probably generally over-priced and will correct itself. Companies with high P/Es will have to justify this valuation through strong operational cash flow, strong and effective R&D budgets, low debt, and not be over leveraged.
Responses to the posted article about current “bullishness” in the market and also stated are other questions about the future markets. There are several statements that suggest that the present market is undervalued or fairly valued, but the prices projected in the future may not be so bullish. The financial engineering or the creation of innovative products has lead to discovery of their flaws, which has lead to the current crunch. As stated in the article, “the summer brought several troubling financial issues to the forefront” suggest that scionomics may be playing a part in the bullish attitude. The weak dollar is also helping the market coupled with the continued “bad news” about Chinese companies. The technology sector is currently bullish and the financial sector is bearish right now. The weak dollar is making our exports cheaper abroad and any imports more expensive. Companies with strong manufacturing presence in the USA are seeing an increase, so why are consumer discretionary and services sectors and materials and processing sectors bearish? Is this because of the outsourcing of the past couple of decades is a concern? The advantages of outsourcing manufacturing are no longer being realized due to the weak dollar?
The statements in the article “…call equity markets either fairly valued or undervalued, managers participating… there may be new reasons to begin considering fixed income investments..” does not sound like a bullish statement or that the present value of stocks are really under or fairly valued by these managers. The article goes on to say how “bullishness for corporate bonds more than doubled … US Treasuries recorded one of their highest bullish scores … Are these managers just playing a scionomic game and making sure investor/society confidence remains optimistic? There appears to be a “flight to safety and that managers fundamentally believe that the bigger opportunity still lies in the equity markets … it is true that risk is being repriced ..” by the market. This statement in the article suggests to me that the market may be overpriced, but no one knows until risk is revalued – no one knows what the risk premium on equity should be over treasuries. This suggests that stocks can not be adequately valued, so how can these managers comment on the market being under or fairly valued – when they do not even understand how to value the current market? Review the current yield curve, the 1 month rate was 3.40 % and the 6 month rate was 4.20% or a pretty steep upward sloping curve. Couple this with rising fears of a recession and oil reaching $100 per barrel – is the market overpriced? The article suggests that many managers are bracing themselves for inflationary pressures and looking for safe havens for periods of recession and inflation. The strong increases in gold and silver suggest inflation is looming.
The article finally tells us where the managers see under or fairly priced stocks and it is in large cap growth and not the market as a whole. The title is thus a little misleading and meant to draw the reader in. These companies are a safe haven probably due to low debt, great cash flow, and strong brand recognition. These companies have great credit and not a default risk. These companies also will remain very liquid, due to these reasons. They can continue to offer commercial paper and issue bonds without concerns from investors. These companies also need short-term debt instruments, where small cap etc may be after long-term debt instruments. Review of the yield curve reveals that the investors are not very interested in long-term bonds. They are having strong expectations of higher interest rates to come (based on the pure expectations theory).
One last note here, the links provided are about the Feds power and ability to control the overall market and economy. It suggests that the tools the Feds has are out dated and not effective anymore. The deregulation of the industry has dampened their power. Their tools are really for depository institutions and the market is not controlled by just depository institutions. This sub-prime mess was caused by non-depository institutions, so do we need to reevaluate how the Fed operates to correct the current issues at hand?
http://www.financialweek.com/apps/pbcs.dll/article?AID=/20070924/REG/70921012/1016/ECONOMY
http://www.financialweek.com/apps/pbcs.dll/article?AID=/20070924/REG/70921011/1016/ECONOMY
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Another article suggests:
http://www.capmag.com/article.asp?ID=4926
It relates to stock valuations through forward earnings as related to the risk-free interest rate. Looks at the risk premium of stock if it was treated as a bond. Claims are all based on historical statistics (S&P’s 3 yr, 5 yr, 10 yr, etc P/E avg). The current market is undervalued based on this assumption. This was probably seen by most of the class when using the P/E valuation method. It is also recognized that this is a long-term view of the current market’s valuation and not that the stock may actually be overpriced in the short-term market. The article also states that if the market was to adjust to historical valuations, then the S&P 500 would rise significantly.
All of these models and consensus of the market is undervalued is based on a foundation of companies meeting or exceeding FY2008 earnings. This is all directly related to the economy, monetary policy, and society’ mood about spending. The Fed’s action of lowering the Fed Fund Rate supported the undervaluation claims of the equity market.
See what you think and if the valuation methods we used support the statements in both of the articles.
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