dreaminofsailin, here is some information on p/e ratios by Archie Richards:
October 25, 2004
PE Ratios Signal that Stocks Everywhere are Screaming Buys
The stock market is a screaming buy.
Many market professionals don't think so. But those guys are often wrong.
Market technicians note that for the last 8 months, the Dow Jones Industrial Average has trended downward. They think this indicates the Dow will continue falling.
Nonsense! Those chart pictures look like they ought to work, but they don't. Historic price trends predict nothing. The market cares only about the future, not the past. Forget about the market professionals. Buy stocks. They're cheap.
A good way to measure the value of stocks is price-earnings ratios ("PE's," for short). Here's what the term means:
When you buy a suit or a dress, you like the feel of the cloth. You like the form, shape, and color. You'd rather have the item than the money you paid for it.
But with a stock, there's nothing to touch. All you have is a brokerage statement showing the number of shares you own. Oh, you could travel thousands of miles and put your hands on the company headquarters and factories. But this won't tell you much, because it's the people working inside that make all the difference. You can't go around touching them, because they'll call the cops.
The shares make you the owner of a tiny portion of a business enterprise. If the company has 1 million share of stock outstanding and you have 100 shares, you own 1/10,000th of the company. Nice going; you're a capitalist.
How can you estimate the company's worth?
The method used most often values the stock in terms of the company's earnings. Let's say the stock price is $10 a share. For the last 4 quarters, the total earnings per share were $.50. The price is 20 times larger than the earnings. The price-earnings ratio is 20.
Price-earnings ratios vary a lot. The stock of USG, which makes building materials, is priced at $23.06. Its earnings in the last 4 quarters totaled $5.16 a share. Dividing the price by the earnings, the PE ratio is 4.5, which is low.
Cell Genesis, a nanotechnology company, is priced at $5.16. In the last 4 quarters, the company had losses. This makes the PE infinite, which they tell me is pretty high.
The Standard & Poor's 500 Index now stands at 1,096. Barron's shows the earnings of the 500 companies at 56.15. The index is larger than the earnings by 19.5 times. That's the market's price-earnings ratio: 19.5.
Compare these results to bonds. If a bond is priced at $1,000 and the annual interest paid by the bond is $40, the price exceeds the interest by 25 times.
But bonds aren't valued this way. The numbers are reversed. The interest ($40) is divided by the price ($1,000) to obtain an "interest yield" of 4 percent.
So much for the hypothetical. The actual interest yield on 10-year Treasuries is 3.98 percent.
As mentioned, the S&P 500 index is 19.5 times larger than the earnings. But to make a comparison with the interest yield of bonds, those numbers have to be reversed. Divide the earnings (56.15) by the index's current level (1,096) to arrive at the "earnings yield" of 5.12 percent.
Let's see: The interest yield on 10-year Treasuries is 3.98 percent. The earnings yield on the S&P 500 is 5.12 percent. The yield on the stocks is higher.
This is uncommon. When the earnings yield of stocks is higher than the interest yield of bonds, stocks invariably rise.
All over the world, the earnings yield of stocks is higher than the interest yield of bonds. This is true in Japan for the first time in modern history. Everywhere, stocks are terrific buys.
Never mind the glum comments of television business reporters and other so-called market experts. Just buy stocks - U.S. and foreign. Don't expect to hit the absolute bottom prices. No one can do that. If you're not already in, get in. The time to buy is now!
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