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From: raha@sphinx.UChicago.UUCP (Bob Hettinga)
Newsgroups: net.invest
Subject: Re: Stock market is NOT a present value machine
Message-ID: <1812@sphinx.UChicago.UUCP>
Date: Wed, 19-Mar-86 03:47:15 EST
Article-I.D.: sphinx.1812
Posted: Wed Mar 19 03:47:15 1986
Date-Received: Fri, 21-Mar-86 04:05:49 EST
References: <2023@uwmacc.UUCP>
Reply-To: raha@sphinx.UUCP (Bob Hettinga)
Distribution: net
Organization: U. Chicago - Computation Center
Lines: 62



There are several reasons that P/E ratios would not be directly related to
price.  The most important are: 1. Earnings could be in the form of a one time
shot of cash from somewhere; 2. The earnings figures could be cooked -- some
people use some pretty sophistic tax dodges, like changing inventory methods
-- and the more experienced investors are discounting the information in the
price of the stock; or, 3. the market sees the impact of something coming (the
old saw: [buy/short] the rumor, [sell/buyback] the news).

I tend to look at P/E's as more of a psychological indicator than anything
else.  If a company's making so much money (low P/E), why is the market so
down on it?  I like to screen for low P/E s , then see what the story is.
If I believe the story, I stay away.  If I doubt it, I set up my decision
rule for selling, and then I buy the stock.

I now see all you efficient market hacks out there gagging.  This is a
classic stock picking strategy called bottom fishing.  It's a variant on the
old Graham and Dodd trick of buying value.  At first glance, low P/Es seem
to represent a hole in the Efficient Market Hypothesis big enough to drive a
truck through.  It seems that a proffessor at Michigan used CRSP tapes to
check out Ben Graham's Intellegent Investor strategy (buy if the stock has a
low P/E and is selling below Book Value).  It turns out that while buying
stocks with book values below share price will not give you returns above
the market (in fact, in his case, he got yields *lower* than the market),
buying stocks with Low P/E ratios will in fact give you give you above
market returns.  Not outrageous returns, but more than the market will give
you.  

Conceptually, this all makes sense.  After all, what's the book value of a
Mexican oil loan these days, or US Steel's South Works?  You can bet neither
has been completely written down yet, though both are worth a lot less than
the accountants say they're worth.  P/E ratios seem to me to represent the
current state of the rumor mill, or as the finance hacks around here like to
say, the effects of the information in the market versus the information the
company has on it's P&L.  So, this really doesn't reflect anything nasty on
the Efficient Markets Hypothesis.  It's just that the market (please don't
hit me) can be wrong.  I know, that's like saying that the temprature
outside can be wrong to some people.  But the current temprature can change,
just like stock prices, and some people like to try to predict their
behavior :-).

Yes, Virginia, the Market is a Big Present Value Machine.  But value is
transitory, illusory, and essentially someone's opinion... Unfortunately
(fortunately?) the market values those 'opinions' in cold cash.


Bob Hettinga
(Sorry, I never could disclaim very well with rocks in my mouth)


-- 

___________________________________________________________________________

		.....and then I woke up.
___________________________________________________________________________

Bob Hettinga
Center for Continuing Adolescence
!ihnp4!gargoyle!sphinx!raha
NASA Contract Number : (wait a sec, ... I wrote it here someplace...)