Using P/E to determine shorting opportunities

I

inandlong

Disguised as a strategy topic - I'd like to also pose the question to be discussed in this thread.... why do we pay price multiples?

As I mentioned in another thread, it has always seemed ridiculous to pay multiples of earnings. Historically this multiple is around 12. I ask you - does anyone pay you 12 times what you generate in earnings?

I have been using P/E in this bear market to filter shorting opportunities. This has been a value driven market for 2 years now, and P's have dropped with E's, especially those companies with no E's.

But my selections haven't been limited to tech stox. By and large I have shorted successfully NYSE stox. Ridiculous price multiples are there too. Stocks like GE and GM have been excellent candidates. Well, four months ago they were when their P/E's were out of line.

Anyone else using this fundie?
 
You must be careful, PE is a reflection of current price and past earnings. Many times a company may be trading at a very low PE because the past earnings were fake (Enron), one time non recurring, or changes in the company sales , lawsuits and such, that will make it impossible for the company to maintain that level of earnings. Let us not forget those companies that use extremely questionable accounting practices. Sometimes a very low PE should be a red flag.
 
Right Dan. And P/E's are very relative to the industry also. A low P/E is a very relative term.

On the other hand, I think a high P/E is easier to determine.

:)
 
Originally posted by inandlong
why do we pay price multiples?

I have been using P/E in this bear market to filter shorting opportunities. This has been a value driven market for 2 years now, and P's have dropped with E's, especially those companies with no E's.
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Leading sectors usually have higher P/E's. Try comparing the historical P/E prior to the market runup to the current P/E on the issue. If I see a negative on a company and it has what I believe is a high P/E for current conditions and sentiment, then yes I start looking at the charts etc to determine if the issue has a trading opportunity. Similarly if the company has a positive and I think the sector is in favor I will look for a trading opportunity on the plus side.
 
Did you guys check out the article referenced in the Gems: Methods and Systems thread that talked about a stock picking "robot" that looked at the following:

It assembles a 10-stock portfolio using a method that is simplicity itself. It begins with all the U.S. stocks having more
than $500 million in market capitalization—about 1,800 candidates.

Then it discards those that have total debt greater than common equity, lopping off 600 issues or so. From the remaining 1,200 stocks, the robot selects the 10 with the lowest price-to-earnings ratios. (The P/E is the stock price divided by the past four quarters’ per-share earnings.) That’s it. Any graduate student in finance could design a more sophisticated
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http://www.elitetrader.com/vb/showthread.php?s=&postid=141182#post141182

I don't know why you couldn't simply reverse the requirements to come up with a good shorting model. So look at stocks with high capitalization, with total debt greater than common equity, and pick the ones with the highest PE ratios as your shorting candidates.
 
I thought this sight was called elite trader not elite investor. Using PE's is a buch of hog wash! Take a look at any growth stock from the past decade or two. Home Depot, Cisco, Microsoft, Dell. Their PE's were way too expensive and before they made their moves they had PE's of 200x earnings.

I know someone who has owned Cisco from the IPO and his cost basis is .17cents per share (adjusted for splits). When they went public their PE was 200 times and has never been less than 30 and was mostly above 50. So would you short it! Even after these big declines the stock is up a hundred fold. And if you look at when the stock was at 82, it's PE wasn't that much different to now (when it's at 13). Their PE based on last year is 44 (.25 cents per share into 11). When the stock was at $82 the earnings expectations were $2.50 per share so the PE then was 33. Shows you how much the analysts were right in their earnings assumptions. How can you use a number from the past? Stocks that are going to get hit are going to have a problem with earnings. The first hint of problems will be declining prices in the stock followed by the market realizing that their is an earnings problem. At this point in time, they would pop up on your "stock scanner" showing as a low PE stock. You would have to research each and every one and look for all the reasons behind the decline and get a handle on the earnings going forward - no easy task unless you really understand the biz model.

What changes is expectations of earnings. Then analysts that are plugging in numbers now for 2003-2005 can be horribly off or they could be spot on. Either way, forward looking earnings is better than looking at past earnings with current prices.

But are you a trader or an investor? Wait for the price to break to confirm your expectation and then short it - who cares about the PE. If you insist at least use forward looking numbers (PEG) although bear in mind that the analysts are often wrong so any decrease in estimates should be a sign to run for the hills.
 
Everybody looks at P/E's to begin with because that is what everybody tells you to do. Even if you are a long term value investor, just looking at the P/E is foolish. Many stocks have single digit p/e's just before they declare bankruptcy. It is very common for the best performing stocks in a group to have the highest p/e ratio's and the worst in the group to have the lowest p/e ratios. If you intend to make money, you need the best performers, not the worst performers. One thing I can guarantee you is that Warren Buffett doesn't just look at the p/e and say "ooh, that's cheap ! ". That is what the suckers do, which is how the smart people dump their losers onto the suckers.
 
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