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Posted by on August 14, 2008, 7:43 pm
> All a low P/E signals is that the market doesn't like the stock right now.
Historically bank stocks have been an outlier, on the low side, when
it comes to P/E. To me this says a lot more than bank stocks are not
the flavor of the day.
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Posted by Tad Borek on August 14, 2008, 8:50 pm
honda.lioness@gmail.com wrote:
> I think we agree that the low P/Es the market normally assigns banks
> is due to buyers perceiving banks as riskier.
The "right" trailing P/E hinges on earnings growth, or lack thereof
(bankruptcy being an extreme form of "negative earnings growth").
A stock or sector could have a low P/E because of a low earnings growth
rate. First, just intuitively...who would pay the same "P" for a dollar
of earnings that will stay there at $1 forever, vs. a dollar that will
be $1.50 within two years? Or, in finance jargon: highly simplified
Gordon model where earnings are paid as dividends says
P/E = 1/(r-g)
r is expected return demanded by investors
g is growth rate
assume competition for capital, r = constant
no growth means lower P/E
(it may not matter in the macro/model sense whether dividends are
actually paid - so says Modigliani-Miller theorem)
> For a few years now I have been seeking
> an explanation of why historically the S&P 500 P/E has averaged 15.
> Why is 15 "magic"?
A simplistic view (mine) walks into it by starting with a 4% inflation
rate over the long run, adding a premium for "the inconvenience of not
having your money for while, and perhaps not getting it back," plus
another for investing in equities instead of nominal-return corporate
bonds. But why that has on average landed at an earnings yield of around
6.7% (1/15) is anybody's guess! Also - even more fundamental - why is
there inflation, and why 4%?
-Tad
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Posted by on August 14, 2008, 9:26 pm
> honda.lion...@gmail.com wrote:
> > I think we agree that the low P/Es the market normally assigns banks
> > is due to buyers perceiving banks as riskier.
>
> The "right" trailing P/E hinges on earnings growth,
Do you think the following statement says the same?
"Historical differences between sector P/Es often hinge on historical
sector differences in expected earnings growth."
If so, sure. Though at the moment, I give more credence to the theory
that earnings by banks are more erratic, and so their stock price
volatility is higher. Like the steel, auto, and oil industries, IIRC.
> Also - even more fundamental - why is
> there inflation, and why 4%?
Why single digit inflation? Or why whatever number?
I bet the answers to this are very similar among economist minded
folks.
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Posted by Tad Borek on August 15, 2008, 2:01 pm
honda.lioness@gmail.com wrote:
>> The "right" trailing P/E hinges on earnings growth,
>
> Do you think the following statement says the same?
>
> "Historical differences between sector P/Es often hinge on historical
> sector differences in expected earnings growth."
Yes, if by P/E you mean trailing P/E, and I think it's true whether it's
a stock, sector, asset class, etc. "Trailing" is important though
because there isn't the same justification for a high forward P/E -
which arguably never makes sense. One oddity to me about P/E studies
(whether of stock, sector, or asset class) is that overwhelmingly they
focus on trailing P/Es rather than forward P/Es. But a new owner at t=0
is not really interested in the prior earnings, of which he'll receive
no benefit. Instead the investment decision is (or should be) based
entirely on anticipated earnings. But there isn't much good data about
that, while it's easy to run studies based on current price and
historical EPS. How would one determine historical forward P/Es? Only
current IBES data about sell-side analyst earnings estimates is readily
available, not historical (not from sources I'm aware of). And sell-side
analyst earnings estimates are questionable source of the "E", anyway
given the "cheerleader" aspect to them. You'd need to know the earnings
estimate of everyone who was looking at the stock (including those who
decided not to purchase).
>> Also - even more fundamental - why is
>> there inflation, and why 4%?
>
> Why single digit inflation? Or why whatever number?
>
> I bet the answers to this are very similar among economist minded
> folks.
Interestingly there are still quite a few theories about it, even though
it's been one of the most studied and written-about topics in economics.
-Tad
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Posted by Elle on August 15, 2008, 2:45 pm
> honda.lioness@gmail.com wrote:
snipping much to meet guidelines and try to stay at least a
little consistent with the subject line
>> "Historical differences between sector P/Es often hinge
>> on historical
>> sector differences in expected earnings growth."
>
> Yes, if by P/E you mean trailing P/E, and I think it's
> true whether it's a stock, sector, asset class, etc.
Others and I were talking about how the banking sector's
historical P/E differs from, say, the S&P historical
average, hence my focus on the banking sector. Yes, I mean
trailing P/E.
Aside: It might be more accurate to speak of how the banking
sector's P/E historically lags that of the S&P 500 and other
sectors, rather than attest that banking P/Es always average
below 15. I have not had a chance to look at this fully.
> But a new owner at t=0 is not really interested in the
> prior earnings, of which he'll receive no benefit.
Aside: If memory serves, Ben Graham was adamant about using
only trailing P/Es. He was in the camp that felt, as you put
it, forward P/Es never make sense. He has elaborated on why
he feels this way, and I thought him persuasive.
>>> Also - even more fundamental - why is
>>> there inflation, and why 4%?
I meant to query: Do you mean why is there single digit
inflation? Or did you mean why does inflation set on X in
such-and-such country at such-and-such time? Places like
Israel had triple digit inflation from 1978 to at least the
mid-1980s, for example. So I do not follow why you chose 4%.
I still feel many have a good intuitive answer to what may
cause inflation. Either way, it is one of those economic
topics that I think is particularly fraught with human
psychology, anthropology, etc., so it's not a topic I care
to explore here. Inflation and deflation happen. Six months
ago I could buy a 2008 SUV for $30,000. Today I would pay
$28,000 for the same vehicle. Why? Well one big reason and
lots of smaller reasons.
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