Investing In Up Or Down Markets

Stock prices can be analyzed in a number of ways, to determine whether they are high, low, or fairly priced.

The Price to Earnings Ratio (PE) takes the most recent price of the shares and divides it by the most recent earnings, usually for the last 12 months. This Trailing PE allows you to compare a company’s price today with its price last year or 5 years ago, on an apples to apples basis.

It also allows you to compare to other companies in its industry (or the industry average) or to the stock market as a whole. You also can compare to stock markets around the world.

The PE is imperfect at best, as company managements have some ability to manipulate the earnings part of the PE. They may draw a small amount of earnings forward, or they may defer earnings. And, as I have mentioned previously, they may inflate per share earnings by buying back company stock.

For example, if a company’s shares sell for $10 and they have $1 of earnings, then the PE would be 10. What they do with the $1 of earnings – reinvest it or return it to shareholders – shouldn’t affect the PE. However, if they use the whole $1 to buy back company shares, then the earnings divided by the reduced number of shares might appear to be 11+.

Clearly, the shareholders didn’t gain anything. In fact they have lost the future earnings if the money had been reinvested in their company.

A variation on the trailing PE is the Cyclically Adjusted PE (CAPE), which essentially is a 10 Year PE Ratio. This smooths out the finagling and other variations in the way earnings are calculated.

Above is a CAPE comparison of stocks in different world markets (courtesy of Peter Schiff at Euro Pacific Capital). Using the CAPE shows that US stocks are quite high by world standards, while stocks in Norway are on the low side.

Another analysis tool is the Dividend Yield. Investors buy stocks expecting a return on their investments in a future dividend stream. On the above chart, you can see that US stocks currently pay a low dividend yield, while Norway companies are somewhat more generous.

Yet another valuable metric is the expected growth rate, sometimes measured as earnings or sales growth and sometimes compared to the stock PE ratio (PEG).

I’ve used an online stock screener (Yahoo!) looking for stocks (Market Cap $1-10 Billion, any Dividend, any PEG, and any estimated earnings growth).

There were 9 stocks with a PEG of 0.25 or less (expected growth at least 4 times the current PE). Of these, three are paying a dividend between 8.5% and 9.5%!

At the other valuation extreme on the same screen, there are 13 stocks with a PEG of 6 or higher (PE is 6 times the expected growth rate), and three which pay 0%, 0%, and 1.7% in dividend yield. It may be reasonable to expect that these last three stocks will do less well than the first three, over the next year, whether both groups rise, both groups fall, or there is a split result.

I mention this because there are different ways to invest your money. While I am comfortable with my money mainly in Precious Metals and their company stocks, you may not be. You may prefer to buy only the best from a screen such as I have described, you may prefer to “sell short” the worst, or you may prefer a combination – buy the best and short the worst.

I AM NOT recommending anything (I do own PDLI), but here is a listing of the six stocks from the above screen:

My point is not to ask for you to plunk down your hard earned money on my say so – on PM Stocks, the screened stocks above, or a stock in relatively low priced Norway – but rather to show you that there are various possibilities. You don’t have to settle for just as (more?) risky Treasuries or bank accounts which pay less than CPI returns.