Today's Economic Lesson of the Day: The P/E Ratio

Yo Cappy:

What do you think of these?

The Crisis of Credit Visualized - Part 1
http://www.youtube.com/watch?v=Q0zEXdDO5JU

The Crisis of Credit Visualized - Part 2
http://www.youtube.com/watch?v=iYhDkZjKBEw&feature=related

So, by that chart, the current P/E ratio of the S & P is comparable to 1970-71's, not 1974-5's. Given that the current bear market was worse than 1973-4's, that's pretty scary.

5800 by mid may.

I agree that the P/E ratio is an important number, but it needs to be viewed in the context of another figure: the US 10-year treasury yield, or what economists call the "risk-free return" (on the basis that if the US defaults on its bills, we're going straight to hell). Currently, that sits at 2.76%. From 1969 to 1975, that rate bounced between 6.16 to 7.99%.

On the assumption that investors act rationally ('scuse me while I snort quietly), a dollar earned from a stock (as in the "E" above, not the "P") vs. a dollar earned from Treasuries should be the same. But, since companies don't pay out all their earnings in the form of dividends (nor should they; some earnings need to be retained for capital improvements), we also need to look at the dividend yield of the SP500. In the late 60's-mid 70's, the yield bounced around the 4%; last year, it was 2.03%, and with dividend cuts coming right and left this year, I expect to see it fall even lower.

Now, in 1970, the SP500 yield was 3.5% while the 10-year Treasury was 7.35%, for a ratio of about 50%. Today, we have an SP500 yield of (let's be generous and say) 2%, and a 10-year yield of 2.76%, for a ratio of 72%. That suggests that the SP500 yield is currently too high, or the 10 yr is too low, or a bit of both.

Jamie Dimon of JPM Chase is doing his bit to help; today, he announced that Morgan is cutting its quarterly dividend to a nickel. GE, which fell to another decade-long low yesterday, currently yields 14%, and most people expect that dividend to be cut as well. Company after company announcing dividend cuts do not provide the environment needed for a base in stocks, let alone rebound.

Keep your powder dry, kiddies. There will be a great buying opportunity ahead, but it's not here yet.

Shiller is not in Obama's Cabinet because he is a P&E guy. To qualify for a Cabinet position you should be a regulatory person. The Dow is in its current status because Bush failed to regulate banks and he had P&E people as his advisors.

Personally I pulled my money out of the markets years ago and invested in my own businesses, places were I know what's going on and have ultimate influence over.

Finally...retirement is a fools paradise. Only fools would invest in snake oil stock market salesmen barkers. When Obama regains regulation over banks the markets will start to come back until then the Dow is headed for a big fat zero!

investing from the 80s

DEAFllamas

Dividends
Earnings
Assets
Future
if you couldnt justify things on the first four criteria then you may as well buy llamas because everyone said they wanted one but no one knew why.

I've put off my retirement about 5 years. Good thing I enjoy my work. I'm looking to see some attractive buy "signals" to happens in late 2009/early 2010.

What the Captain didn't tell us is that at some point when earnings for many companies become a negative number the P/E ratio becomes fairly irrelevant. For instance, if Westinghouse has negative earnings, the P/E won't even be mentioned. You can't have a ratio if earnings are non-existant. Negative earnings will cause the share price to dive. When earnings do return to positive territory the market won't wait to see a favorable P/E ratio. Markets lead and as soon as some possible signals start coming out the share price will advance ahead of any earnings report.

That is why one buys of "rumor" and sells on "news".

not stirred enough said, said: "When Obama regains regulation over banks the markets will start to come back until then the Dow is headed for a big fat zero!"

It takes a Leftist to view the destruction of people's savings and cheer. Obama is truly your guy.

So stirred, when are you signing up for concentration camp guard classes? I hear its going to be a growth industry in Obamaland.

Better plan

Instead of shoring up pensions of one sector of the economy, politicians should help create a national pension plan that would supplement CPP, he says. All workers not already in a company pension plan would be automatically enrolled although people could opt out.

"It's not being socialist. It's being smart. Once you figure out you're getting screwed, you ought to do something about it," says Ambachtsheer.

http://www.ottawasun.com/Comment/2009/02/24/8504166-sun.html

SDA gets results once again.....I have been saying this all along...no bailouts for individual pension plans....either give it to us all, or nothing at all.

Phantom,

I'm not cheering because I'm a Leftist, I'm cheering because the thought of saving for retirement is such a stupid concept. The fact of the matter is retirement is the ultimate act of dumbness.

Think about it...just when you reach the pinnacle of knowledge, ability and experience you quit. And to do what...most people say to enjoy life and take it easy; after all you've earned it haven't you? How did you earn it; by scrimping, saving and investing wisely? No, by being stupid! Sacrifice is stupid, think of suicide bombers. They make the brain dead sacrifice to kill themselves. Sacrificing today for a better financial future is no different.

If you don't agree with me just go talk to retired people...the things they talk about are rife with paranoia and trivial obsessions. Is that the future you want for yourself?

Seriously, what are you a moron, you want to keep people working till they are 80, until they are old and infirm, rhetorical question, we already know the answer.

narciso,

Both my parents worked into their eighties. I saw it firsthand and I know it can be done. In fact their income went up every year until their deaths. I plan to do the same. Makes the concept of RRSPs and retirement saving ridiculous.

Stirred you are on crack. Most retirees - and I deal with hundreds of them - enjoy being retired. Sure many could have worked an additional five years but almost all of those are happy they did not.

But a very large percentage - perhaps a third - are suffering some sort of health problem that makes working forty a week an agonizing prospect. Do you think roofers and floorlayers with knee and back problems want to work into their seventies? And the fact is most people live into their eighties and ninties if they don't save for retirement they will be eating kibble. Is that what you want for your retirement?

Stirred,

You can enjoy hanging out in an office or cubical all day until your 80.

I prefer to be sitting on a boat fishing with a beer in my hand thank you very much. If that makes me stupid and Selfish. Then I'm stupid and Selfish

Predictions where the DOW JONES bottoms:
1000
2000
3000
4000

Not Stirred: I do not buy the premise that Bush failed to regulate the banks. What regulation did he repeal that caused this crisis? What regulation did he not enact that would have presented this crisis. European banks which are way more regulated are in even worse shape. The most regulated parts of the American banking system are the ones that had the greatest failure. One study I just read (I'm trying to find the link) says that Bush brought in more regulations than any other president since Carter. If bank regulation is so critical then why hasn't the Big Zero implemented these fantastic new rules the minute he took office - he seems to have had time to do everything else.

George Bush approved deficit budgets, he cut taxes but not spending, he refused to veto pork and earmark laden bills, he brought in TARP I and auto bailouts, he did a stimulus bill last spring which gave every American extra cash ($60 per month vs Obama's current $10 per week). For all of these things George Bush should be criticized by libertarians and fiscal conservatives. For a supposed lack of regulations criticism is not justified in my humble opinion.

Stirred:

By " planning to do the same" assumes you will be healthy right up until you die. You have a less than thirty percent chance that you will be so fortunate. So are you proposing that if you are not as lucky as your parents that you will simply become a ward of the state and expect people like me to pay for your retirement?

For the record I plan to work to some degree until I keep over. But I am also planning to have the financial capacity to do otherwise should I change my mind or have no option but to quit work.

IMO retirement is a state of mind. It means you have reached the point financially where you can choose not to work without impoverishing yourself at some point in the future. This is a point in life that is both liberating and empowering for many.

BTW stirred, how do your parents feel about your 'plan'?

Sorry, how did they feel ?

Cannot help thinking that the reduction in the perceived interest rates for bonds,coupled with the inevitable inflationary cycle created by the writing of money, plus the profitability of the surviving effectively run companies will, in the medium(?)term, mean a more attractive place for retirees to place their funds will still be the Stock Market. The people who felt pressured, either by the need to maintain an existing life style or just panic to get out of the Stock Market, thereby magnifying the impact of the situation, through Mutual Funds redeeming billions of dollars, will be the same people who again panic and buy in at a higher P/E to obtain a 3% dividend over a bond rate which is below inflation. Cheers

Stirred:

I worked and saved, just as you don't recommend, and got secure enough that I retired so that I could achieve some goals that wouldn't be possible if I was working. Like building a little wooden boat, like getting on a motorcycle and riding across the country. I'm happy with that, and my blood pressure is down.

You're planning to work until you're old, and you're sounding cranky already. Best of luck; just don't expect me to pay for your health care when your inability to have fun leads to heart problems.

The current joke making financial planning rounds is that "Freedom 55" has now been enhanced and replaced by "Freedom 95".

After all the bailout money in the US, this will be inflationary at some juncture down the road. You just have to wait until it gets passed through to the taxpayer.

Meanwhile, Congress is piling on another $4 Billion dollar payoff to cronies and friends of the Democratic party.

http://finance.yahoo.com/news/House-Democrats-propose-410B-apf-14450221.html

"House Democrats unveiled a $410 billion spending bill on Monday to keep the government running through the end of the fiscal year, setting up the second political struggle over federal funds in less than a month with Republicans.

The measure includes thousands of earmarks, the pet projects favored by lawmakers but often criticized by the public in opinion polls. There was no official total of the bill's earmarks, which accounted for at least $3.8 billion."

Meanwhile the US dollar's crash over the last 2 years will make their exports cheaper. Eventually those companies will return to profitability.

Yep, MikeSr this is the typical overreaction of green investors who have never seen a downturn.
The tide always goes in and out. Never get swamped by transient events.

Cheers

Hans-Christian Georg Rupprecht, Commander in Chief

1st Saint Nicolaas Army
Army Group "True North"

There is some truth to lack of regulation leading to the current economic crisis, but this reduction in regulation started with Carter and Regan, Bush SR. and Clinton all reduced regulation further and most of the damage had been done by the time George W. Bush was in office ... In 2004 he did try to increase regulation in the system but couldn't get support from the senate or house, and by then it was too late anyways.

Now, I'm not a big fan of regulation and it should be used primarily to prevent criminally moronic actions; like qualifying people to buy a home at twice the historic average price based on the teaser rate of an adjustable rate mortgage amortized over 40 years with mortgage payments at 60% of take-home income and 0% down.

Now, what not-stirred-enough doesn't understand is that Obama is actually rewarding these criminally moronic actions by bailing out the banks ... After all, the executives of these large banks will lose their bonus this year (and maybe the next) because of the optics of the bail-out, but soon enough they will be getting twice the bonuses they used to receive (while charging double the fees on users) because they need to recover their increased tax load.

NoOne,

In several previous posts I have stated my position is a definite no to bailouts. I'm not big on regulation either. It's just that there is a side to business that attracts people with no scrupples or integrity. Regulations should flush these people out and deny them the abilty to prey upon the public and investors.

A lefty telling us that sacrifice for one's future self is stupid.

Yet, doesn't lefty doctrine tell us that sacrificing for one's neighbour is the highest ideal?

I understand perfectly. I'll cancel my RSP (into five-year GIC's, thanks muchly, even though folks used to laugh at me.) deposits and just send the bill to you, Not Stirred.

Foreclosure Phil
http://www.commondreams.org/archive/2008/05/29/9274

not stirred enough said, classic university kid with a kid's grasp of reality. Mom's still buying the toothpaste eh?

Behold the results of our "progressive" education system. Eat, drink and be merry, for tomorrow will never come! The One will pay your credit card bill for you, and all will be lovely and wonderful because Barry is The Man.

Truly, Obama is your guy. Don't be whining to me when you're arthritis starts hurting while you flip those burgers.

And you wonder why we call you people retards.

Yukon,

Beware the tax implications of cancelling RSPs
and going to GICs.

May I suggest you do what I have done...purchase a high powered German sports car and put the rest into vintage guitars.

I only know lefty ideology and couldn't care less about doctrine...I'm one of those existentialist leftys.

P/E is one way to look at a company; but, essentially, it is a comparator. Company A to Company B on their relative P/Es.

Another, and often more useful way, is to look at discounted cash flows. Try reading Ian Campbell who actually is a business valuator http://www.stockresearchportalblog.com/2009/02/economists-on-public-company-share-values/

As a general rule, though, trying to pick the "bottom" is a mugs game. Much better to look for solid companies making things people need which you understand.

retirement? freedom 85?

like Willy Nelson said, "I've outlived my pecker".

as an old guy retired on his own dime i work two to three days a week for something to do. my wife would probably leave me if i did not get out of the house during the winter. summer no problem, golf don't ya know.

Jay Currie:

Don't disagree with you that trying to pick tops and bottoms is futile. People who say they can do it are lying. That said, there are times when you can spot an under or over valued asset. Check out this chart:

http://home.earthlink.net/~intelligentbear/com-dow-au.htm

When the Nasdaq cracked in 2000, it was pretty clear to me that gold was undervalued, as was oil, especially given Easy Al's monetary policy. I didn't buy oil at $10/bbl, but I did buy it at $30. I didn't buy gold at the absolute bottom, but I bought it at $275. I can see gold moving up to $2,000/oz, as the Dow meanders to 8,000; that would give it a 4:1 Dow:gold ratio, which is the lower trendline on the chart. At the same time, based on yield and other factors, it might become clear that stocks are undervalued, and it will be time to buy back in.

There's no bigger lie in investing than "buy and hold"; if you bought the Dow in 1997, you're underwater now, even after today's rally, just because of a decade of inflation. Portfolio allocation is the key determinant of overall return, and to that properly, you either need to do a lot of research on your own, or find a good advisor. Neither is easy.

Beware the tax implications of cancelling RSPs
and going to GICs.

I think you've misinterpreted my comments. My RSP's are already in GIC's. Anywhere from 5.5% to the latest batch at 3.25%. I'm not going to be getting rich, but I've got 20 years until my pension is fat enough to walk out the door.

I'm cheering because the thought of saving for retirement is such a stupid concept. The fact of the matter is retirement is the ultimate act of dumbness.
Posted by: not stirred enough said at February 24, 2009 10:44 AM

I always suspected not stirred was a couple cans short of a six pack. But the above statements prove it.

I'll go out on a limb. We will see another sucker's rally to about 7800 then it will slide to about 6500. Buy point is anywhere from 7100 to 6500.

I think the absolute floor is about 6000 based on Tobin's Q formula which will probably come around in May.

One other issue that will complicate things is that most of the banks will probably get kicked out of the Dow in favour of consumer staples and industrials.

Interesting -- Anybody notice that the P/E chart looks a lot like the 'global surface' temperature charts put out by the IPCC et al.
Maybe recent climate change is caused by P/E's.....