On Jan 31, 2000, the average P/E of the S&P 500 was 25.6, and the Nasdaq 127. These numbers
have fallen considerably since then, to about 18 for the S&P and 49 for the Nasdaq. Companies
that have lost money in the past four quarters have no P/E ratio.
It is better to use forward estimated earnings for comparison if a company is growing at an
accelerated pace, since the past 12 months may be quite different than what is projected for the
coming year. But if you choose to use the estimated forward earnings rather than the trailing
earnings in your comparisons, you’re working with guesses instead of facts.
If you stop to think about it, even a 20 to 1 ratio is hard to justify. If a company is earning a
net 5% on sales, it would take 20 years to earn a full return on your money, even if the company
was paying out all earnings as dividends.
In reality, companies use earnings to redeem bonds and repay loans. They pay guaranteed dividends
to preferred shareholders and keep a cash reserve to meet the business’s current needs if sales
slow. They need funds for research and development, and expansion of the business. Your share of
the earnings, the dividend, might not be much after these priorities are met.
“Value” style investors look at the P/E ratio as a major indicator of the fair value of a stock. If
the number is lower than the average, they say that it may be a bargain. If the ratio is higher
than the average, they say that the stock is probably overpriced.
I agree that if other important factors are weighed along with the P/E ratio, a healthy company in
a growing industry with a low ratio is definitely a bargain. If you limit yourself to “undervalued”
companies, you will miss the best stocks.
Most of the biggest winners in the past years have been stocks with HIGH P/E ratios, even before
they made their biggest moves upward in price, including Microsoft, McDonald's, Home Depot, and
Wal-Mart. AOL had a P/E of 100 in 1994, and then rose 14,900% by Dec 1999.
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When placing orders through your on-line broker, create a paper trail of all transactions. If
you lose money because a trade was not executed, present copies of your evidence to your broker,
asking for swift reimbursement of your loss due to their negligence.
If you don’t obtain satisfaction, arbitration is your next step. Overall, 60% of cases
considered by arbitrators go in favor of the customer and against the brokers. If your loss is
substantial, consider hiring an attorney.
Make a habit of printing out the information on your web browser screen when you place an order.
This may be the only way you can prove that you placed a buy, sell, or limit order at that time.
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