Sign in to follow this  
F-16

The eternal Price/Earnings bubble

Recommended Posts

It's a long term problem in the stock market. Traditionally, stocks with a price/earnings ratio <15 were considered "profitable" by those "in the know." Now the standards are relaxed, and "other people's money" is considered "profitably" invested at a P/E of 20 or even 25.

Earnings vary, and are sometimes negative, when a company reports a loss on its books. So the real issue is the reciprocal of Price/Earnings, or the Earnings Yield.

At P/E=15, the earnings yield is 6.67%.

P/E=20, EY=5.00%

P/E=25, EY=4.00%

At this point, the investor is taking on great deal of risk for an expected profit no better than that of a Treasury bond.

Investors traditionally look for a 15% annualized gain in the stock market to compensate them for the risk. An earnings yield of 6.67% just doesn't get you there, because in one way or another, in the long term, all stock market gains have to flow through the company's books at the earnings yield rate compared to the price of the stock.

I am not especially "risk-averse" but I do not gamble, and I am not willing to place my money at such great risk for such small gain: investors need consistent single-digit price/earnings, or the 15% long-term growth in the stock market simply is not there.

Earnings drive growth, but financial advisers sell "growth" stocks at exorbitant price/earnings on pie-in-the-sky expectations. Such overpriced stock is a gamble and not an investment, and yet that has been the market ever since the crash of 1987.

Share this post


Link to post
Share on other sites

Create an account or sign in to comment

You need to be a member in order to leave a comment

Create an account

Sign up for a new account in our community. It's easy!

Register a new account

Sign in

Already have an account? Sign in here.

Sign In Now
Sign in to follow this  

  • Recently Browsing   0 members

    No registered users viewing this page.