With P/E ratios is without question a useless approach to review stock value. However, almost everyone really does it. The market desire for P/E ratios is so persistent that even we include them in our database. But our P/E's are different from what you'll discover in your newspapers.
One particular good reason for the distinction in P/E's is that we use 12-month forecasted income, not income that is based primarily upon 12-month trailing performance. Everyone knows that the stock market is a forward looking beast. Traders gamble on potential future, not really the past. So why make a barely useful number less informative than it could be? One additional differentiation is that VectorVest a P/E ratio for each and every stock. For a variety of reasons, including low, zero or negative earnings, you will not find P/E data for about 20% of the stocks listed in media.
Although the main convincing factor is P/E ratios are barely beneficial is that the review of P/E's is completely subjective. There is no independent standard for knowing whether a P/E ratio is too high or too low. Any individual may provide you any kind of number of factors why they feel a stock's P/E is too high or too low, and who has to disagree with them?
Years ago, we learned that anyone could tell whether a stock was over or undervalued by dividing its P/E ratio by its earnings growth rate. The theory was that high P/E ratios could be justified by high revenue growth rates. So a stock was deemed to be overvalued when the (P/E)/Growth ratio was more than 1.00. This (P/E)/Growth ratio test was made popular by Mr. Peter Lynch, the fantastic manager of the Fidelity Magellan Mutual Fund, and it became known as the PEG ratio. The idea of comparing a stock's P/E to its earnings growth rate made sense to me, so I was off to plotting earnings data on semi-log paper and calculating growth rates like you wouldn't believe. Yet, quite a few things are troubling.
The one thing that bothered us the most was that we couldn't find a mathematical derivation for the (P/E)/Growth Ratio test. This was before Google, of course. My search of PEG Ratio on Google got 408,000 results in 0.29 seconds. Wikipedia says the PEG Ratio, "is only a tip of thumb and has no accepted underlying mathematical basis." This statement is not true. Actually, G/PE to PEG is preferred because all of the other key indicators in VectorVest are favorable when they are above 1.00.
As of at this time, It is never seen an independent derivation of the PEG or G/PE ratio. Years ago, we used to show this derivation in our Two-Day seminars and the most interesting thing about it is that it shows that the appropriate test ratio for valuation is 1.00 when, and only when, the AAA Corporate Bond Rate equals 10%. Test ratios below 1.00 are suitable when the bond rate is under 10%. This phenomenon is explained in our Stock Analysis Reports.
Have, for example, the case of F5 Networks, FFIV. It closed Wednesday at $96.36 per share. VectorVest had it valued at $68.71 per share with an RV of 1.43, GRT of 28 %/Yr., P/E of 34.29 and G/PE of 0.82. Is it undervalued or overvalued? If you compared the Price of $96.36 to Value of $68.71, you'd say that it's definitely overvalued. If you're a P/E type of person, you'd have to admit that a P/E of 34.29 is pretty high, so the stock is probably overvalued. If you're a PEG lover, you'd say a PEG of 34.29/28 = 1.22 is greater than one, so the stock is overvalued. You might think a G/PE person, like me, would say the stock is overvalued because 28/34.29 = 0.82 is below 1.00. However, I know enough to consult the VectorVest Stock Analysis Report. Oh my goodness, it says FFIV may be considered to be undervalued because 0.82 is well above the operative G/PE test ratio of 0.13%.
Everything, except the Stock Analysis Report, says that this stock is overvalued. What's going on? Well, last week we said that stock value goes up when interest rates go down. Interest rates currently are at historic lows and the Stock Analysis Report is taking that into account. It's telling the truth. Stocks are cheap. Take a look at RV. At 1.43, it's saying that this stock is likely to outperform a comparable investment in AAA Corporate Bonds by 43% over the next three years.
Think about it. What kind of return will you get on a bond paying 3.6%? In three years you'll make a total return of 11.93%. Don't you think a stock growing at 28 %/Yr. and an RS of 1.44 can appreciate more than 11.93% in three years? Sure, I know FFIV is currently overvalued, but with its high growth rate and fine financial performance, RV says that it's a better investment than buying 3.6% bonds. Anybody who uses P/E or PEG ratios to value stocks without taking interest rates into account is Playing A Fool's Game.
BOTTOM FISHING WITH THE BEST
If you're looking to make money virtually every time the market rallies from a dip, you've got to watch this week's "Strategy of the Week" presentation. Visit the VectorVest University and Mr. James Penna will show you how to do it by "Bottom Fishing with the Best."
Want to learn about stock analysis or stock analysis software? Start here: http://stockchartingsoftware.wordpress.com
One particular good reason for the distinction in P/E's is that we use 12-month forecasted income, not income that is based primarily upon 12-month trailing performance. Everyone knows that the stock market is a forward looking beast. Traders gamble on potential future, not really the past. So why make a barely useful number less informative than it could be? One additional differentiation is that VectorVest a P/E ratio for each and every stock. For a variety of reasons, including low, zero or negative earnings, you will not find P/E data for about 20% of the stocks listed in media.
Although the main convincing factor is P/E ratios are barely beneficial is that the review of P/E's is completely subjective. There is no independent standard for knowing whether a P/E ratio is too high or too low. Any individual may provide you any kind of number of factors why they feel a stock's P/E is too high or too low, and who has to disagree with them?
Years ago, we learned that anyone could tell whether a stock was over or undervalued by dividing its P/E ratio by its earnings growth rate. The theory was that high P/E ratios could be justified by high revenue growth rates. So a stock was deemed to be overvalued when the (P/E)/Growth ratio was more than 1.00. This (P/E)/Growth ratio test was made popular by Mr. Peter Lynch, the fantastic manager of the Fidelity Magellan Mutual Fund, and it became known as the PEG ratio. The idea of comparing a stock's P/E to its earnings growth rate made sense to me, so I was off to plotting earnings data on semi-log paper and calculating growth rates like you wouldn't believe. Yet, quite a few things are troubling.
The one thing that bothered us the most was that we couldn't find a mathematical derivation for the (P/E)/Growth Ratio test. This was before Google, of course. My search of PEG Ratio on Google got 408,000 results in 0.29 seconds. Wikipedia says the PEG Ratio, "is only a tip of thumb and has no accepted underlying mathematical basis." This statement is not true. Actually, G/PE to PEG is preferred because all of the other key indicators in VectorVest are favorable when they are above 1.00.
As of at this time, It is never seen an independent derivation of the PEG or G/PE ratio. Years ago, we used to show this derivation in our Two-Day seminars and the most interesting thing about it is that it shows that the appropriate test ratio for valuation is 1.00 when, and only when, the AAA Corporate Bond Rate equals 10%. Test ratios below 1.00 are suitable when the bond rate is under 10%. This phenomenon is explained in our Stock Analysis Reports.
Have, for example, the case of F5 Networks, FFIV. It closed Wednesday at $96.36 per share. VectorVest had it valued at $68.71 per share with an RV of 1.43, GRT of 28 %/Yr., P/E of 34.29 and G/PE of 0.82. Is it undervalued or overvalued? If you compared the Price of $96.36 to Value of $68.71, you'd say that it's definitely overvalued. If you're a P/E type of person, you'd have to admit that a P/E of 34.29 is pretty high, so the stock is probably overvalued. If you're a PEG lover, you'd say a PEG of 34.29/28 = 1.22 is greater than one, so the stock is overvalued. You might think a G/PE person, like me, would say the stock is overvalued because 28/34.29 = 0.82 is below 1.00. However, I know enough to consult the VectorVest Stock Analysis Report. Oh my goodness, it says FFIV may be considered to be undervalued because 0.82 is well above the operative G/PE test ratio of 0.13%.
Everything, except the Stock Analysis Report, says that this stock is overvalued. What's going on? Well, last week we said that stock value goes up when interest rates go down. Interest rates currently are at historic lows and the Stock Analysis Report is taking that into account. It's telling the truth. Stocks are cheap. Take a look at RV. At 1.43, it's saying that this stock is likely to outperform a comparable investment in AAA Corporate Bonds by 43% over the next three years.
Think about it. What kind of return will you get on a bond paying 3.6%? In three years you'll make a total return of 11.93%. Don't you think a stock growing at 28 %/Yr. and an RS of 1.44 can appreciate more than 11.93% in three years? Sure, I know FFIV is currently overvalued, but with its high growth rate and fine financial performance, RV says that it's a better investment than buying 3.6% bonds. Anybody who uses P/E or PEG ratios to value stocks without taking interest rates into account is Playing A Fool's Game.
BOTTOM FISHING WITH THE BEST
If you're looking to make money virtually every time the market rallies from a dip, you've got to watch this week's "Strategy of the Week" presentation. Visit the VectorVest University and Mr. James Penna will show you how to do it by "Bottom Fishing with the Best."
Want to learn about stock analysis or stock analysis software? Start here: http://stockchartingsoftware.wordpress.com
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