As the name implies, this fund is comprised of 1000 large cap stocks. In their top 5 categories are stocks covering financial services, utilities, consumer discretionary and staples.
This index carries a P/E of 14.4 - giving you an earnings yield of 6.95%. That makes the P/E below the historic mean and well below the Dow Jones Industrials (P/E = 23.89). These stocks are on sale!
But, a word of caution. As I've written previously, by all measures that I follow, the market is at a pretty lofty level. I've taken - and recommend - a hold approach. So, if you're in this fund currently, stay put but, if you're not in the fund you may want to stay put until a correction occurs. At that point, I'd take a serious look at this index as part of your portfolio.
The P/E Ratio - Part II
Last time I focused on the mechanics of the P/E ratio. This time, I look at some of the conclusions you can draw from the P/E.
What would you say is more desirable, paying $10 for each dollar of earnings or paying $20 for the same earnings dollar? If you answered $10, you understand the first implication of the P/E. A P/E of 10 indicates that you'll be paying $10 for each dollar of company earnings. Based on historical trends (more on that in a moment) that's pretty good.
Let's look at this another way. Are you willing to wait 20 years for the company to obtain - in earnings - what you paid for the stock? That's right. If you have a stock with a P/E of 20 you are, in effect, investing in a company that will take 20 years to earn what you invested in the stock. So, you might ask yourself, does this business have what it takes to make consistent - or better - earnings over 20 years? Let's reframe that a bit. Do you know of any business or economic cycle that has lasted 20 years without suffering the ill effects of recessions, business slumps, or the like?
In two broad brush strokes you now know what the P/E tells you about a stock, stock mutual fund, or ETF. But, the true power of the P/E comes from understanding its historical value.
In his book, "Unexpected Returns", Ed Easterling delves into the past performance of P/E ratios. Here are some of his findings...
1. Over the past century the average P/E has been 15.8
2. The P/E has a natural peak in the mid-twenties
3. At the start of - and during - a bull market, P/Es are low and rising
4. At the start of - and during - a bear market, P/Es are high and declining
5. Moves toward either inflation or deflation results in lower P/Es.
I'm writing this after market close on 11/13. The P/E for the Dow Jones Industrials is 23.52 and the S&P 500 Index is 18.54.How about indexes that may be available through your retirement fund:
| Russell 1000 Index | 17.1 |
| Russell 1000 Growth Index | 20.7 |
| Russell 2000 Index | 20.3 |
Five out of five indexes are above the historic average and three are beginning to approach a peak!
"But," you say, "What about stocks like Google (goog)? They sport a P/E of 68 and appear to be making money!" Yes dear reader, there is some truth to that. Still, how much money have they really made? Since October of 2005 that stock has been moving in a band between $350 and $450. In fact, here's something else the P/E suggests...
Stocks and funds with high P/E ratios are priced for optimal performance! One mistake, one earnings hiccup, and investors will dump that stock in a heartbeat.
High P/E's can make money for traders - not investors. What's the difference? Traders think in terms of days and weeks. Investors think in terms of months and years. To think like a trader, to profit like a trader requires time - lot's of time. Time to analyze various stocks, time to look at charts. Time to watch the market throughout the day for any of those hiccups I mention which may cause a change in course. At that point, the trader needs to be nimble enough to get out of the market in a hurry before he's stampeded by others headed for the exit.
For the most part, we're investors. We think longer term. We look at weekly charts. We appreciate buy low, sell high. And, to do that, we will look for - among other criteria - low P/E stocks and funds.
The P/E ratio is one of the more prominent tools in my investing toolbox. Investment philosophies have been built around the P/E and with good reason. In articles to come you'll learn about other tools I have in my toolbox and how I use them too.
Next Time In the Fund Informer...
Two weeks ago I was in Manhattan and had an interesting conversation regarding management styles with one of my colleagues. That discussion got me to thinking. So, the next issue will depart a bit from the normal format for an essay on the subject. As with everything else in these pages, I hope you find the article informative - if not instructive. Till next time...P.S. I promised you a special bonus. As many of you know, almost two years ago I started a diet which resulted in a seventy pound weight loss. I know dieting is a very personal and frustrating topic but, I thought I'd write it down for anyone that may be interested. Just click here for The Ninety Bite Diet.
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