InvestorsHub Logo
Followers 679
Posts 140247
Boards Moderated 40
Alias Born 03/10/2004

Re: DiscoverGold post# 22196

Friday, 08/18/2017 8:36:08 AM

Friday, August 18, 2017 8:36:08 AM

Post# of 54865
Here’s the shocking truth about the Russell 2000’s P/E ratio
By Mark Hulbert | August 18, 2017

Glaring omission artificially lowers small-cap sector’s valuation

Ready for today’s investment pop quiz?

Which of the following is the actual P/E ratio for the Russell 2000 Index RUT, -1.78% the well-known benchmark for the small-cap sector of the stock market?

a. 25.6

b. 19.9

c. 78.7

Believe it or not, the correct answer is “c.” That means that the small-cap sector is not only hugely overvalued in its own right, it is in relative terms as well. As you can see from the chart below, the Russell 2000’s true P/E today is higher than it was at either the top of the internet bubble or the 2007 bull market peak.



That’s important information in light of the Russell 2000 this week dropping below its 200-day moving average. Rather than providing a floor underneath the index, its true valuation will be exerting a force towards even more declines.

Don’t be too hard on yourself if you didn’t answer my pop quiz correctly. Hardly anyone does. That’s because the most obvious places you’d go for the answer suggest the index’s P/E is far lower. FTSE Russell, the company that created and maintains the index, says that the Russell 2000’s P/E ratio is 25.6. iShares, the keeper of the popular exchange-traded fund benchmarked to the Russell 2000 IWM, -0.07% , pegs the index’s P/E at 19.8, as of Aug. 16.

Credit for pointing out these discrepancies goes to Vincent Deluard, head of global macro strategy at INTL FCStone, a financial services firm. What neither FTSE Russell nor iShares take into account when calculating the index’s P/E, Deluard told me in an interview, are companies with negative earnings. Since nearly a third of the companies in the Russell 2000 index are losing money, this omission has huge consequences.

To be clear, neither FTSE Russell nor iShares hide the fact that they ignore companies with negative earnings, since they indicate in footnotes that they do so. And it’s at least superficially plausible why such companies would be ignored when calculating an average P/E, since a P/E ratio becomes nonsensical when the “E” is a negative number.

But Deluard isn’t buying that excuse. Though the proper calculation takes more work, the alternative is the functional equivalent of reporting “profits before expenses” — which he characterized as not unlike the creative accounting practices used during the internet bubble. To calculate an index’s true P/E, he points out, all you need to do is divide the combined total market cap of all component companies by the sum of all those companies’ trailing 12 months earnings.

When Deluard did those calculations, he discovered that the Russell 2000’s true P/E is 78.7.

To put this in context, compare the index’s earnings yield of 1.3% (the inverse of the P/E ratio) to the 2.2% yield on the 10-year Treasury TMUBMUSD10Y, -0.05% That means a 10-year Treasury note now yields almost a percentage point per year more than the small-cap sector.

Needless to say, you may have other reasons for believing the small-cap sector to be undervalued right now. But don’t try to justify your bullishness by claiming that the Russell 2000’s P/E is in the range of 19 to 26.

http://www.marketwatch.com/story/heres-the-shocking-truth-about-the-russell-2000s-pe-ratio-2017-08-18

DiscoverGold

Click on "In reply to", for Authors past commentaries

Information posted to this board is not meant to suggest any specific action, but to point out the technical signs that can help our readers make their own specific decisions. Your Due Dilegence is a must!
• DiscoverGold

Join the InvestorsHub Community

Register for free to join our community of investors and share your ideas. You will also get access to streaming quotes, interactive charts, trades, portfolio, live options flow and more tools.