Nice rules of thumb about valuation

Discussion in 'Trading' started by crgarcia, May 9, 2007.

  1. The P/E is a good starting point for valuation. It can never be considered a pure metric, though, because of changing expectations about interest rates and earnings growth. Nevertheless, there are rules of thumb that can help assess whether the P/E is appropriate or not.

    The first is to compare the current P/E with interest rate yields. These provide competing rates of return. The yield on stocks is the inverse of the P/E (E/P). The current 16.8 P/E, for example, represents a yield of 5.96%. This is well above the current yield on the 10-yer note of 4.64%. This implies that stocks are significantly undervalued.

    Another rule of thumb is that the P/E should be about 20 less the rate of inflation. At about 2 1/4% or so, the inflation rate implies that the P/E should be about 17.8. By this approach, stocks are also undervalued.
  2. What does the net income have to do in regards to yield from a stock? I know you can get a percentage this way, but what's the point and what is the correlation?

    Also, P/E is useless as a metric in a bull market. Might as well buy the crap and hope for it to float to the top rather than buy "expensive" stocks that are actually doing well...
  3. P/E is based on earnings which can be easily manipulated so it is a toos up whether you can rely on it or not.
  4. It's an analysis intended for the whole stock market as a whole, not for individual stocks.