The Corpus Callosum

“Green Shoots” in Graphs

Courtesy of Chart of the Day...

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Click on the graphs to see the Chart of the Day explanations
for the data.

The top chart shows the aggregate earnings, over time, of the companies
in the S&P 500 Index.  The second chart shows the ratio
between the aggreagte price of the stock, and the earnings of the
companies.

Oversimplified view: A low price-to-earnings ratio means that you are
not paying much, to get a share of a company that is earning a
lot.  A high P:E ratio means that you are paying a lot for
companies that aren’t earning so much.  Although there are many
factors involved in determining whether a certain stock is a good
investment, a lower P:E ratio is one indicator that suggests that the
stock is a good investment.

What remains to be seen is whether the turn things around, to get their
P:E ratios down.  But until you see that happen, you really don’t
know what you are getting into, if you buy stock in these
companies. 

Historically, the P:E ratios have been cyclical.  So some people
will be tempted to assume that the P:E ratios will cycle down, turning
their iffy investments into good ones.  However, the current
situation is unprecedented.  That indicates that the old patterns
and assumptions may not apply at this point in time.

This is an illustration of how assumptions can lead to false
conclusions.  It is impossible to conduct one’s life without
making assumptions.  Given that, it is helpful to be mindful of
the assumtions one makes when making important decisions.  It then
is important to look for indications that those assumptions might not
be valid.

When you see things happening that are literally unprecedented, it is
an indication that it might not be valid to assume that historical
patterns will repeat themselves.

Comments

  1. #1 Russell
    May 25, 2009

    I’m curious how you’re calculating that P/E. When I look at SPY’s current P/E, it shows, via Yahoo, as 11.98.

  2. #2 MRW
    May 25, 2009

    Russell,

    There are a number of possible reasons for the difference. The main one is “one-time charges”, which are sometimes counted and sometimes not. I’m guessing that Yahoo is not counting them but Chart of the Day is. From what I’ve read elsewhere, the P/E is a bit north of 20 without the one-time charges and somewhere around 120 with them.

    A couple other factors:
    1) SPY tracks the S&P 500, but is not exactly the same, so the P/E will be different.
    2) The P/E ratio can’t really be continuously calculated, because the E part is only updated every 4 months. The P part is continuously updated, though, so some will estimate the P/E ratio by taking the current P and dividing by the last known E. Yahoo and Chart of the Day may have made different decisions about whether to calculate quarterly or more frequently.

  3. #3 Russell
    May 25, 2009

    Earnings are posted every quarter. Unless they now divide the year into 16 months, that’s every three months, not four.

  4. #4 MRW
    May 25, 2009

    Whoops. Of course, that’s right.

    The point is the same, though.

  5. #5 darmowe ebooki
    May 28, 2009

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