PER P/E Ratio

[burt]

Just to clarify some thinkings I read on this post.
PER is the ratio Price on Earnings.
P/E is something related to the ratio of shares I'm ready to buy at a specific price. It is related to the risk (P/E is low when I THINK, or better I FEEL, the risk as high, P/E is high when I FEEL the risk as low).
There are 2 concepts: 1 figure is related to the past (ACTUAL price versus PAST 12 months earnings), 1 is related to the future (ACTUAL price related to NEXT 12 months).
Now you have to put yourself in the skin of a speculator (NEVER forget that STOCK as STRICTLY NO VALUE, this is NOT and was NEVER an investment, but a guess, a BET on the FUTURE, look at that carefuly, if means the pension system is worldwide DEAD, because it was built, and voted, as a rational system to build a good pension).

So I don't care about the past, I have only 2 questions to solve:
- What to do with my liquididy? (and 1 new question, do I belive in Banks??? If not it is better to put my money on a bear stock market that keeping in banks))
-Do I believe in the future earnings the companies give? (this is a really hard work, because I have to study that, company by company, not on a philosophical or emotional view, but on an evaluation of their real markets)?

So now my ONLY reference is the FUTURE PER ratio, and this is where I strongly disagree with John. This is a really important point.

Now on the other part I agree with him, the market is so rotten, that there will be a crash in the future, I cannot give a date, but I think we need one great phase of optimism, a disruption in the debt system, and at the best time of optimism ("crisis is over") a REAL crash (until now it is just "fun").
For pratical reason (mostly the pyramid of ages and the generational changes + the China system and the peak oil) I don't think this will happen this year, I wait for a crash (minus 50%) at the end of next year and a REAL crash (minus 90%) at something around 2035... but this so far in the future, that we will see.
On my point of view this is much too early to have a new small crash (and I call 2008 crash a small crash), what should(?) happen in 2010.2011 is a disruption of the bank system, BUT the central banks are able (until 2010-2011) to prevent a complete bank system failure.

This has nothing to do with PER, EXCEPT that the PER evaluation is a psychologic evaluation (and THIS has to do with the generational theory), and what is important is the FUTURE PER.

I wouldn't write anything if I thought I had the ultimate truth, so I'd be glad to read the answer of John and from any reader.

Burt

[MarshAviator]

On my point of view this is much too early to have a new small crash (and I call 2008 crash a small crash), what should(?) happen in 2010.2011 is a disruption of the bank system, BUT the central banks are able (until 2010-2011) to prevent a complete bank system failure.

My first point is that a crash is a non-linear event. Your judgment may in fact be correct, but we all have no way to estimate when something like this will happen.

The second point is that the law of diminishing returns will start to have more impact in the near future.
Various so called remedies and fixes (bail outs, takeovers, buyouts) will have less and less impact as time marches on.
Fatigue will soon set in, the last market rally's have an almost giddy quality to them, with people looking on with a hand over the eye.

The debt unwind is just starting, with things such as commercial real estate just now beginning to experience a significant downturn.
Many if not most of the financial sector is in trouble minus the one time charges and other mechanisms for creating short term results.
The long term (market fundamentals) are certainly showing a continued decline (trend).

Commercial paper is still frozen and the volume is at a ten year low and still sinking.

Personally without trying to call a horse race, a crash seems more likely short term (less than one year), it only takes one event (flu, nuke, war, etc.) and the snowball will take off.

Bottom line, people can't make withdrawals from many funds presently, I know of people who once laid off find their debts remain, but their assets are unusable or unavailable. People on the street are running scared and the consumer is shell shocked even now.

[burt]

My first point is that a crash is a non-linear event. Your judgment may in fact be correct, but we all have no way to estimate when something like this will happen.

I agree, no one knows the future, there would be no "market" if it were the case, This was just a scenario I gave, NOT a fixed scenario, but something like a model...

The second point is that the law of diminishing returns will start to have more impact in the near future.

Ok this is a REAL problem with each dollar the Government invests, but were did you get this name for this law, I like theories...

The debt unwind is just starting

As a matter of fact, debt went from companies (before the Asian crisis) toward Private hands (with Reagan-Thatcher madness), and is moving toward Central Banks, after that, no way to move to God, so our financial civilization is DEAD, but it can hold for years.

People on the street are running scared and the consumer is shell shocked even now.

Normaly this is a mark for a LOW, meaning that the stock market should (?) move higher within the next year (my opinion is that it needs first to retrace 50%)

BY THE WAY my comment was on the PER ratio, not on the so called "market" (on MY opinion this is really a stupid name, but this is the name everyone uses)

Regards Thank your for your reply

[MarshAviator]

Burt Wrote:

Ok this is a REAL problem with each dollar the Government invests, but were did you get this name for this law, I like theories...

Wiki has a good summary.
While the Law was named for economic reasons, a good analogy is the space race:
When NASA first started making rockets, they were say 90% reliable.
If you are going to ride one, that's not very good.
So as a first effort you try to improve to say 99% (now careful to avoid the Walter Cronkite syndrome) that's a 10% improvement ((99-90)/90)*100),
but the effort and cost are more likely to be as much as the initial investment with a yield of 90% reliable.

Now repeat, 99% still means 1 per 100 launches meet failure, still not really great so the target is now 99.9% reliable ( or about 1 in 1000 failures), now that's getting better, but in order to achieve this you have to do a lot testing and development and the cost are expanding disproportionally to the relative improvement.

Another simpler is the garden analogy, if you have a small (1 acre plot) garden and work it your self you get a certain yield, add another worker and you get a big improvement, yet another and still improvement, but at some point there are so many people that you saturate the work with resources but can't get any improvement in yield. There eventually are people standing around with nothing to do, adding more has no impact on yield.

Anyway there are better expanations with search engine (google, Wikki etc.).

Regards,

Kurt

[John]

Discussions of Law of Diminishing Returns:

** Fed's desperation move may be prompted by $50 billion Madoff swindle
** http://www.generationaldynamics.com/cgi ... 17#e081217

** UN expert calls biofuels a 'crime against humanity'
** http://www.generationaldynamics.com/cgi ... 07#e071107

** Food prices continue to increase around the world.
** http://www.generationaldynamics.com/cgi ... 10#e050810

John

[burt]

Just thank you to both for the different examples. I knew this law without having the name, the examples are nice and someday I'm going to use another entry for food, because I think that we are going to have a world problem pretty soon (what makes me mad is that this problem has solutions IF humanity wanted to build one, but within a few years there won't be any more solution at all).

I go back to PER- Why is john so oriented towards PAST PER? (that was THE point of this entry)
Regards

[mannfm11]

I go back to PER- Why is john so oriented towards PAST PER? (that was THE point of this entry)
Regards

Why? Because the others are fictions. Stocks are valued by a formula P=d/(k-g) where P is price, d is dividend, K is capitalization rate and g is growth rate. I did a lot of work with the SPX using this formula. What happens is people get bullish and they begin to believe that price appreciation is what drives stocks and that earnings is how they are valued. I graduated from Texas A&M with a degree in finance and this is the only financial formula I can recall for stocks. Truth is that earnings are all over the place. The financial valuation of anything is the present value of all discounted future receipts from an asset. This valuation model actually overvalues stocks because it is a model of forever and most companies go broke eventually, though it would give a very low value of the SPX if one was to use the rule of thumb 9% annual return out of holding stocks due to the fact that dividends would have to represent a much greater proportion of the 9% in order to reach 9%. My studies have shown me that growth is rarely over the long haul, in excess of 1% of inflation, and inflation for the last 80 years has averaged in the 3% range. To get 9% would mean the SPX would need to be reduced to around 550. You can't use future PE because the formula is a growth formula. Also, to project any given year means nothing. The PE has very little to do with the capacity to pay dividends, except that usually about 50% of earnings can be used to pay dividends. Thus if the PE is 14, which the bulls will try to tell you is too low, The dividend yield is going to likely be in the 3.5% range. Again, this implies a 7% to 7.5% long term return, not the 9% the bulls expect. Truth of the matter is BBB bonds are priced to yield higher and most corporations today would do well to be rated BBB. Bonds are superior assets to stocks on a risk basis.

[John]

Dear Barry,

> Why? Because the others are fictions. Stocks are valued by a
> formula P=d/(k-g) where P is price, d is dividend, K is
> capitalization rate and g is growth rate. I did a lot of work
> with the SPX using this formula. What happens is people get
> bullish and they begin to believe that price appreciation is what
> drives stocks and that earnings is how they are valued. I
> graduated from Texas A&M with a degree in finance and this is the
> only financial formula I can recall for stocks. Truth is that
> earnings are all over the place. The financial valuation of
> anything is the present value of all discounted future receipts
> from an asset.

That's a good explanation.

For further information, here's somethign I wrote in 2005 comparing
stock market valuation to real estate appraisal:

** WSJ article Bernanke - errors and omissions
** http://www.generationaldynamics.com/cgi ... 08#e051208

John

[gerald]

John:
Regarding your "Burnanke- errors & omissions" link and the real estate appraisals comment,
your "almost' right on, regarding apartment buildings. ( sorry about about my lack of links to the above site) This other issue is " Carefully" mentioned in appraisals.( I have been in the apartment business, inner city Chicago for over 35 years.) However, you have not mentioned this other VERY important issue, and that is social/economic. If you want to make real money in real estate, ( and not be a scum bag ) , buy property in an area just outside of an appreciating area and wait for you property to appreciate, assuming appreciation moves in you direction. If you want to loose big money, buy property in an area that is deprecating. These issues can over ride every thing. Real estate is people and the QUALITY of people. Don't think so, then what is the problem with Fanny May and Freddy Mack ?

[burt]

Why? Because the others are fictions.

I agree BUT (a big BUT) Stock so called market IS a ONLY a FICTION, it's a HERD fiction where people ONLY think in term "Bargain, I buy"-"Benefice OR Risk, I sell", think about the value of a piece of paper.
This has absolutly NO SENSE, NO VALUE except in what the people think about the FUTURE.
It is NOT Rational in NO WAY.

Nothing to to with the value of a concrete thing (even buildings), which has a value because it exists.

You can't use future PE because the formula is a growth formula. Also, to project any given year means nothing.

Sure, you are right on a RATIONAL point of view. On the very very long term (but then aren't we all dead?) rational gets right, BUT
-a-man is NOT rational (stupid, yes, rational no) AND
-b- man likes (need?) to be part of the herd AND
-c- to be rational you need to know the rules BUT rules changes at every minute in the economical world....
so, on my point of view PAST doesn't mean ANYTHING, FUTURE is fully unknown and is a fiction, PRESENT is REAL, and the stock market is a PRESENT evaluation of the Herd EMOTION about the future (without forgetting that what is SAID by the media could be (or could generate?) the opposite of what people THINK, this is the success at some time of the so-called "contrarians").

Regards

PS there was some studies done on the FUTURE PER which give quite reasonnable results (in term of years) (better than PAST PER).
See, but in french the studies of Aglietta, for example, he is not alone, but this is the most complete study on the subject, sorry if it is in french.