Why the Price-Earnings Ratio is a Hoax

Tesla Spotlights 
Curse and Cure

According to a rampant hoax, the ratio of price to earnings (PE) is the mainstay for gauging a stock for investment. The yardstick is meant to divine the likely direction and extent of the price level downstream.

Unfortunately, the PE ratio can and often does vary hugely from one stock to another whatever their future prospects might be. Moreover, the quotient has a way of swinging wildly over time even for a given equity. As a result, the PE metric is hereby exposed as a treacherous guide to predicting the market. 

According to the party line, a high value of PE implies that the stock is overpriced and will thus crumple before long. In reality, though, the quotient can remain lofty for ages or even climb higher. 

From a different angle, the PE quotient tends to rise with the likely rate of growth in future earnings. For this reason, the PE ratio relative to the growth rate is a much better yardstick for vetting a stock. 

That is, the PE ratio may be divided by the growth rate, G. The latter term denotes the estimate of growth in earnings on an annual basis, expressed as a percentage of the profits actually garnered over the previous 12 months. The resulting quotient is known as the PEG yardstick.

The PEG is far more consistent than the PE throughout the stock market. As a consequence, an extreme level of PEG goes a long way in gauging whether a stock is overpriced, underpriced, or moderate.

Despite this fact of life, the mass of participants – ranging from part-time amateurs to full-time professionals – believe the PE ratio to be the mainstay for valuation. As we noted earlier, though, the PE varies a great deal regardless of future prospects and is therefore pretty much useless for sizing up a stock. Instead, the PEG yardstick provides a better metric by far in gauging the zest for the widget among market participants.

On a positive note, investors in the aggregate seem to grasp the bunkum behind the PE ratio on a subconscious plane even as they affirm its primacy at a conscious level. Here is an example where people say one thing, but do something else.

To round up, investors are impulsive creatures that like to band together. For instance, the plungers pile into the ring in the heat of a bubble and flee en masse in the freeze of a panic. One upshot is a wild ride in the ratio of the current price to past earnings. For this and other reasons, the PE is a lousy guide to valuation. On the bright side, though, the punters are far more consistent when the PE is adjusted by the future growth of earnings. 

Here is a rare instance where the actors as a group do the sensible thing despite their faulty grasp of the marketplace. Whether or not a gamer believes in the fable of the PE, they must act according to the PEG in order to prevail. Otherwise they suffer the consequences and often pay dearly as a result. 

In short, the shrewd investor in order to survive and prosper has to pursue a cogent strategy in practice even if they embrace the myth of the PE from a conceptual slant. In reality, the PEG is a far better gauge for divining the current appeal and future promise of all manner of stocks.

NOTE:  The full report is titled, “Why the Price-Earnings Ratio is a Hoax”. The document in PDF form is available at ResearchGate

#Investment #Tesla #Stocks #Growth #Hoax #Myths

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MintKit Growth Index – Update 2021

A Benchmark for Spry Growth at Modest Risk

It has been a rough year for everyone as the coronavirus pandemic roiled the real and financial markets. One nasty blow was the crash of the stock market in the spring. Luckily, though, the bourse rebounded promptly and set a new record by the end of the summer. 

After thrashing around in the autumn, the market again scaled an all-time peak by the end of the year. As a result, the flagship benchmark – namely, the S&P 500 Index – rose by some 16% over the previous year. 

When the stock market forges ahead, high-growth stocks tend to outrun their plodding peers. In keeping with the norm, the MintKit Growth Index (MGX) climbed by nearly 48% over the same timespan.

From a larger stance, the MGX upon its launch was set to unity (1); that is, 100 percentage points. From this baseline, the Index reached 173.6965 points at the end of last year.

Looking downstream, the outlook for 2021 is much brighter compared to the gloom of the past year. For one thing, the real economy will recover in stages from the drubbing caused by the pandemic. In that case, the stock market will continue to climb higher.

From a different slant, the politicians whipped up trillions of dollars out of thin air in a frantic effort to stimulate the economy in the throes of the pandemic. One fallout downrange is a swelling fear of inflation which will drive a growing throng of investors into the arms of precious metals such as gold. In that case, the mining industry will fare better than most of its peers in the near future and for many years to come. 

Against this backdrop, the revised roster for MGX takes a moderately aggressive approach to the stock market. Even so, the goal for the coming year centers on zesty growth with ample stability rather than lusty vigor with stellar potential.

NOTE:  The report is a slide presentation under the title of “MintKit Growth Index – Update 2021”. The file is available in PDF form at MintKit Gist

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