Best of the Week
Most Popular
1. Investing in a Bubble Mania Stock Market Trending Towards Financial Crisis 2.0 CRASH! - 9th Sep 21
2.Tech Stocks Bubble Valuations 2000 vs 2021 - 25th Sep 21
3.Stock Market FOMO Going into Crash Season - 8th Oct 21
4.Stock Market FOMO Hits September Brick Wall - Evergrande China's Lehman's Moment - 22nd Sep 21
5.Crypto Bubble BURSTS! BTC, ETH, XRP CRASH! NiceHash Seizes Funds on Account Halting ALL Withdrawals! - 19th May 21
6.How to Protect Your Self From a Stock Market CRASH / Bear Market? - 14th Oct 21
7.AI Stocks Portfolio Buying and Selling Levels Going Into Market Correction - 11th Oct 21
8.Why Silver Price Could Crash by 20%! - 5th Oct 21
9.Powell: Inflation Might Not Be Transitory, After All - 3rd Oct 21
10.Global Stock Markets Topped 60 Days Before the US Stocks Peaked - 23rd Sep 21
Last 7 days
Why Most Investors LOST Money by Investing in ARK FUNDS - 27th Jan 22
The “play-to-earn” trend taking the crypto world by storm - 27th Jan 22
Quantum AI Stocks Investing Priority - 26th Jan 22
Is Everyone Going To Be Right About This Stocks Bear Market?- 26th Jan 22
Stock Market Glass Half Empty or Half Full? - 26th Jan 22
Stock Market Quoted As Saying 'The Reports Of My Demise Are Greatly Exaggerated' - 26th Jan 22
The Synthetic Dividend Option To Generate Profits - 26th Jan 22
The Beginner's Guide to Credit Repair - 26th Jan 22
AI Tech Stocks State Going into the CRASH and Capitalising on the Metaverse - 25th Jan 22
Stock Market Relief Rally, Maybe? - 25th Jan 22
Why Gold’s Latest Rally Is Nothing to Get Excited About - 25th Jan 22
Gold Slides and Rebounds in 2022 - 25th Jan 22
Gold; a stellar picture - 25th Jan 22
CATHY WOOD ARK GARBAGE ARK Funds Heading for 90% STOCK CRASH! - 22nd Jan 22
Gold Is the Belle of the Ball. Will Its Dance Turn Bearish? - 22nd Jan 22
Best Neighborhoods to Buy Real Estate in San Diego - 22nd Jan 22
Stock Market January PANIC AI Tech Stocks Buying Opp - Trend Forecast 2022 - 21st Jan 21
How to Get Rich in the MetaVerse - 20th Jan 21
Should you Buy Payment Disruptor Stocks in 2022? - 20th Jan 21
2022 the Year of Smart devices, Electric Vehicles, and AI Startups - 20th Jan 21
Oil Markets More Animated by Geopolitics, Supply, and Demand - 20th Jan 21
WARNING - AI STOCK MARKET CRASH / BEAR SWITCH TRIGGERED! - 19th Jan 22
Fake It Till You Make It: Will Silver’s Motto Work on Gold? - 19th Jan 22
Crude Oil Smashing Stocks - 19th Jan 22
US Stagflation: The Global Risk of 2022 - 19th Jan 22
Stock Market Trend Forecast Early 2022 - Tech Growth Value Stocks Rotation - 18th Jan 22
Stock Market Sentiment Speaks: Are We Setting Up For A 'Mini-Crash'? - 18th Jan 22
Mobile Sports Betting is on a rise: Here’s why - 18th Jan 22
Exponential AI Stocks Mega-trend - 17th Jan 22
THE NEXT BITCOIN - 17th Jan 22
Gold Price Predictions for 2022 - 17th Jan 22
How Do Debt Relief Services Work To Reduce The Amount You Owe? - 17th Jan 22
RIVIAN IPO Illustrates We are in the Mother of all Stock Market Bubbles - 16th Jan 22
All Market Eyes on Copper - 16th Jan 22
The US Dollar Had a Slip-Up, but Gold Turned a Blind Eye to It - 16th Jan 22
A Stock Market Top for the Ages - 16th Jan 22
FREETRADE - Stock Investing Platform, the Good, Bad and Ugly Review, Free Shares, Cancelled Orders - 15th Jan 22
WD 14tb My Book External Drive Unboxing, Testing and Benchmark Performance Amazon Buy Review - 15th Jan 22
Toyland Ferris Wheel Birthday Fun at Gulliver's Rother Valley UK Theme Park 2022 - 15th Jan 22
What You Should Know About a TailoredPay High Risk Merchant Account - 15th Jan 22

Market Oracle FREE Newsletter

How to Protect your Wealth by Investing in AI Tech Stocks

Despite the Crash, Stock Markets are Not Too Cheap to Buy

Stock-Markets / Stock Market Valuations Dec 19, 2008 - 09:08 AM GMT

By: Money_Morning

Stock-Markets

Best Financial Markets Analysis ArticleKeith Fitz-Gerald writes: For many investors, a low Price/Earnings (P/E) ratio is a sign of value. But don't you bet on it – at least, not yet.

According to Michael T. Darda , chief economist for MKM Partners LLC , analysts have overestimated earnings by an average of 30% to 35% in the last three recessions. For millions of investors who use low P/E ratios as a litmus test for selecting their investments, that's going to be a rather unpleasant shock.


If Darda is right, and our research seems to suggest he is, so-called “cheap stocks” may not be all that cheap. For proof, we can turn to some plain-old high school math. P/E ratios are calculated by taking the price of a stock (the numerator, or the “P”) and dividing it by earnings per share (the denominator, or the “E”). The higher the denominator, the lower the P/E ratio and, by implication, the cheaper a stock appears.

However, if higher denominators can make stocks appear “cheap,” then the opposite is true, too, and that suggests that stock prices may have a lot farther to fall – despite the fact that they've already tumbled 40% or more.

Just how much farther is anybody's guess, but the outlook is not good.

For instance, according to Forbes writer James Clash, “more than a year into the market downturn that threatened Morgan Stanley's ( MS ) survival, the 17 analysts covering the company cut their 2009 mean earnings estimates by 36% to $3.63 per share.” Given Darda's observations, there may be another 35% to go, which would put total expected earnings cuts at 71%.

That sounds harsh, but it may not be out of line. Thompson IBES reports that the analyst community as a whole has cut 2009 earnings expectations by only 7.5% for the Standard & Poor's 500 Index . If they are to be believed, that means that the analyst community expects the average S&P 500 company will have to grow earnings by 15% next year to $91, according to Clash.

We don't know about you, but a time when recessionary flags are flying, we have a hard time buying that (pun absolutely intended).

That's why – at the risk of igniting an e-mail firestorm – we point out that analysts are paid to have opinions and a huge body of evidence suggests that they're strongly encouraged to make them bullish. Not only is this a cozy relationship for investment bankers in general, but it has historically helped Wall Street generate huge commissions from an anxious retail investing public that is desperately seeking good news. This bullish predisposition may be especially true at a time when investors are not inclined to buy – and with good reason.

Compounding the problem is the fact that many analysts focused on specific industries or companies tend to become quite myopic. Far too many don't think outside the box and, as a result, are all too frequently surprised when macro-level events come crashing in on their little world and down on the companies they follow.

Investors who rely heavily on Wall Street analyst estimates are, in effect, driving down the highway using only their rearview mirror. The results are all too predictable.

Among the more infamous examples of these errant estimates was the group of analysts who, back in 2001, continued to recommend Enron Corp . stock all the way into bankruptcy and congressional hearings, based solely on their own “optimism.” Only when Enron shares were trading at less than $1 did the majority of analysts change their recommendations to a “hold.”

When it comes to Wall Street, the fox clearly does guard the financial hen house, so to speak.

In the interest of fairness, we should mention that there were “accounting irregularities” in the Enron case. But that really shouldn't let anybody off the hook.

What's happening now – and why we're leery that things may not be as they seem – is that overall business and economic conditions are deteriorating faster than management is willing to publicly acknowledge (although we're now watching these same management teams slash work forces and shutter plants at a rate we haven't seen in years). And since management “guidance” (the sarcasm you detect is intended) is what drives and shapes Wall Street earnings estimates, this is why things are probably going to get worse before they get better. The earnings figures used in most P/E calculations haven't yet been reduced.

As for the ratings agencies such as Standard & Poor's , Moody's Investors Corp. ( MCO ) and A.M. Best Co ., these, too, are problematic when it comes to the earnings and the ratings that help drive them. Supposedly independent, it's been common knowledge for years on Wall Street that firms wanting higher ratings need only coddle the agencies using a combination of fees and information. Of course the agencies will deny this but history suggests that's like the pot calling the kettle black.  Historically, for example, Moody's, S&P and Fitch Ratings Inc ., have each earned huge amounts of income from fees being paid by the issuers whose credit they're supposedly rating. That's changing, of course, but as the credit crisis has highlighted so aptly, probably not fast enough.

So what does work?

P/E ratios are a start. But that longstanding indicator should be regarded as a relative measure of potential price and performance rather than the do-all stock-screen selector so many investors utilize them as.

When we analyze a company , we prefer to see expanding sales, advancing earnings and plenty of cold hard free cash flow. There's an old saying on Wall Street that “nobody ever went broke on accrual accounting,” but clearly plenty of companies have figured out lately that they can go broke without cash. The best example may well be Detroit's Big Three, which are grappling with this seemingly new reality even though we, as individuals, deal with it every day. As my six-year old son recently stated: “No cash … no dinner.”

One other excellent indicator is a so-called “PEG” ratio (the P/E divided by the growth rate) of less than 1.0. While it's more commonly viewed using 12 month trailing earnings, we find it much more stable when viewed against a historical stream of data that's a decade or more in length. Not only does this help screen out the volatility associated with much shorter time periods, but we find that companies with low PEG ratios calculated in this manner seem represent good value over the longer term.

Especially when compared to a deflated “E” – earnings.

[ Editor's Note : The ongoing financial crisis has changed the investing game forever, making uncertainty the norm and creating a whole set of new rules that will help determine who wins and who loses. Investors who ignore this “New Reality” will struggle, and will find their financial forays to be frustrating and unrewarding. But investors who embrace this change will not only survive – they will thrive.

Money Morning Investment Director Keith Fitz-Gerald has already isolated these new rules and has unlocked the key to what he refers to as “ The Golden Age of Wealth Creation .” But Fitz-Gerald brings more than a realization – and an understanding – to the table, here. After a decade of work, he's also developed a new computerized trading model based on a mathematical concept known as “fractals.” This system allows him to predict price movements of broad indexes, or individual stocks, with a high degree of certainty. And it's particularly well suited to the kind of market we're all facing right now. Check out our latest report on these new rules, and this new market environment .]

By Keith Fitz-Gerald
Investment Director

Money Morning/The Money Map Report

©2008 Monument Street Publishing. All Rights Reserved. Protected by copyright laws of the United States and international treaties. Any reproduction, copying, or redistribution (electronic or otherwise, including on the world wide web), of content from this website, in whole or in part, is strictly prohibited without the express written permission of Monument Street Publishing. 105 West Monument Street, Baltimore MD 21201, Email: customerservice@moneymorning.com

Disclaimer: Nothing published by Money Morning should be considered personalized investment advice. Although our employees may answer your general customer service questions, they are not licensed under securities laws to address your particular investment situation. No communication by our employees to you should be deemed as personalized investment advice. We expressly forbid our writers from having a financial interest in any security recommended to our readers. All of our employees and agents must wait 24 hours after on-line publication, or 72 hours after the mailing of printed-only publication prior to following an initial recommendation. Any investments recommended by Money Morning should be made only after consulting with your investment advisor and only after reviewing the prospectus or financial statements of the company.

Money Morning Archive

© 2005-2019 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in