Market Musings 26/06/21: Why Look at the P/E Ratio?

26th Jun '21 by Edmund Shing

5 comments 2846 reads

Why look at the PE Ratio?

Summary:

Podcast: Give your portfolio a clean bill of health
Report: How to profit from rising inflation concerns
Why the P/E ratio gets too much attention
My favoured Stock Market, Sector, Thematic and asset class picks in Charts

Podcast: Give your portfolio a clean bill of health

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Give your portfolio a clean bill of health

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How to profit from rising inflation concerns

A short report laying out my preferred ways to hedge against inflation in one’s portfolio…

1) Commodities are an obvious investment destination: precious metals, battery metals and crude oil. Commodity-related equities too: gold/silver miners, industrial metal miners, chemicals, paper & pulp.

2) Real estate hedges inflation via rising rents, as long as real long-term yields do not rise sharply: since 2001, US REITs have outperformed the S&P 500, particularly during periods when US inflation expectations have risen quickly.

3) Targeting capital-light, hard-asset companies, information-based companies with high pricing power, low fixed costs: companies that can raise prices while maintaining a low, largely fixed cost base are attractive inflation hedges.

The link below gives access to this short report:

How to profit from rising inflation concerns

Why the P/E ratio gets too much attention

What is the P/E ratio and why is it so widely used by investors?

Well, it is a convenient shorthand metric for valuing companies and markets – the one most commonly used and cited.

“Investors need a quick way to determine how expensive a stock is, and the P/E ratio is the most popular way to do that. The rationale for using the P/E ratio is simple. As a part owner of the business — that’s what a stock is, after all — the P/E shows how much profit you would receive annually for every dollar that you invest in the company. A high P/E means you’re paying a lot for each dollar of earnings, while a low…

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William K

26th Jun '21

Many thanks Edmund. Agree totally about PE ratios. The only comment I would add is that a very high PE, say >200, indicates ultra-high expectations and a possible good short if the quarterly earnings disappoint. And whilst a low PE, say <10, is often a red flag, it seems to be less of a red flag with mining stocks than with non-mining stocks.

Vsihv

28th Jun '21

Hi Edmund,

If one has a 10 year investment horizon & we expect (some high/low/-ve return) over next 6-12 months but low over 10 years, are you not effectively engaging in market timing (presumably you would need to exit if multiples get more stretched).

As for ETFs (and I'm a pretty cynical fellow), but I think this may prove to be a problem. As with all great finance innovations they get pushed/leveraged/expanded until they break.

Being very cynical, I think there is a pretty active effort by some participants to push sh1tcos into indices to facilitate an exit, so smart money can use their bailout funds to dump on retail/pension savers.

Pretty out of pattern for wall street / city to push clients into cheaper products with better returns, so I get the impression that city/wall street is benefitting elsewhere.

andrea34

Interesting to see you post a chart for Oakley Capital Investments (LON:OCI) as this is the largest holding in my portfolio, performance has been brilliant recently.

Edmund Shing

30th Jun '21

Hi Vsihv,

Yes it is usually right to be cynical of "financial innovation", as this has often led to problems/losses further down the line for unsuspecting investors...

With ETFs, they can be a good and bad thing, of course. One should stick to ultra low-cost, very diversified ETFs for best long-term advantage, if you are buy-and-hold. Like MSCI World ETFs, for instance which then confer a high level of sector and regional diversification.

I do not believe that "market timing" is a dirty word, as I have seen many quantitative systems, usually quite simple, that can reliably outperform buy and hold over the long-term, and also often reduce downside risk too. That, after all, was one of the key tenets of the book I wrote, "The Idle investor"...

I actually expect what I consider to be reasonable returns from most stock markets over the next 5-10 years (ex US), in the 5-8% range of total return including dividends. Over a long-term period like that, you would then do well to bias holdings in equities towards the cheapest markets... e.g. Russia, and the UK

Edmund

1st Jul '21

Thanks for the reply.

I try and select stocks for my own portfolio - appreciate it is against the financial wisdom but I enjoy it.

ETFs & ITs are a feature of my wife's portfolio with the core being in SWDA & then additional to EMIM, VEUR, VUKE, MIDD, SJPA and include some thematic ETFs for extra spice - I appreciate some of your suggestions in this space - thank you.

My reasoning for overweighting other regions is that US M/Cap in all world is substantially greater that US proportion of world GDP and then valuation vs growth. I'd suggest the trade you are making is economic risk vs political risk.

Due to fresh contributions, that is some 40% cash but I am uncomfortable putting fresh money for now.

I am somewhat of a permabear (think because my first experiences/insights were .com that bust & then 2008 that bust) but am very uncomfortable with market levels (pretty much everywhere) - I see commentators talk about ex US being cheap, but that is cheap relative to the US which is on multi-decade highs.

Re your sentiment on market timing, I agree, given I am engaging in it! Especially for those that are willing to put in the effort.

For me, I try and balance offence/defense & I would suggest it is a time to be defensive. (Howard Marks Memo last year really helped me while I was somewhat dear in headlights).

Indeed, I have found 2021 more difficult than 2020 (but maybe that is just recency bias)

Sorry - I am not sure why I wrote all that - thanks for your reply & the weeklies.

Vivek

Market Musings 26/06/21: Why Look at the P/E Ratio?

Why look at the PE Ratio?

Summary:

Podcast: Give your portfolio a clean bill of health

Give your portfolio a clean bill of health

How to profit from rising inflation concerns

How to profit from rising inflation concerns

Why the P/E ratio gets too much attention

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Edmund Shing

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