Forum Archive Index - March 2001

[Nigel McCarter <n.mccarter@clear.net.nz>]

Much appreciate the analysis Peter, but I'd differ on at least one key point


>Some research I came across a while ago showed that there is no 
>correlation between a company's expected long term earnngs growth (as per 
>the company's share price earnings ratio) and the long term price change 
>in the company's share. The study was conducted on the FTSE 100 over a ten 
>year period in the nineties and concluded that the correlation between PE 
>ratios and subsequent share performance is zero - stocks with low PEs do 
>no better or worse than stocks with high PEs. In other words PEs are 
>useless as an indicator of future earnings growth.

Whilst it might be true (and I haven't seen the research to which you 
refer) that low PE stocks do not indicator future earnings stock, there is 
a correlation between PE and future share price.  I have tested the 
relationship three times now with the NZ and the Australian Markets.  For 
example for 301 companies between 1996 and 1998 in the Australian market 
see figure 3.2 Shorten the odds page 42 (Australian edition)
However, I also make the following points:
1.  The relationship is weak or non signficant in the short term (less than 
two years)
2.  There is no relationship between price and value
3.  Low PE may also indicate higher risk.

Now the issue here is not the relationship between PE and feps, but the 
relationship between PE and capital gain which is what we are interested in.
For higher PE stocks, it makes sense to look at past eps and predicted 
earnings, recognizing that no company grows at 20% year for ever, and that 
sooner or later the PE will fall back to the market median for the sector.

A sure way for an investor to lose money is to buy a high PE share with in 
a company with poor prospects of growth e.g. telecom
If you are convinced that Baycorp can continue to grow then it is still a 
good buy.
I'm not, so I sold last year

>

Nigel McCarter

Shorten the Odds

Box 23 019 Hamilton
Phone 64 7 858 2429 Fax 64 858 2689
Mobile 025 274 8560


----------------------------------------------------------------------------
http://www.sharechat.co.nz/          New Zealand's home for market investors
http://www.netbroker.co.nz/        Trade on Credit, Low Brokerage. Join now.
----------------------------------------------------------------------------
To remove yourself from this list, please use the form at
http://www.sharechat.co.nz/forum.shtml.