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I remember seeing this graph not too long ago that showed the P/E ratio of the stock market took off in the '90s and it never came back to its historical averag

I remember seeing this graph not too long ago that showed the P/E ratio of the stock market took off in the '90s and it never came back to its historical average range. The graph predicted that the "real" value of the Dow was in the 7,000 - 8,000 range. The people passing around these graphs would have looked like cranky perma-bears a few years ago. Now they look down-right reasonable. It's not a crash, it's a readjustment to prudent pricing.

DanielBMarkham 18y ago
Usually during a re-adjustment the market swings too far the other way by a few points. So I'd be looking for value stocks that have a P/E ratio that's overly low. Find some stock that's getting beaten up beyond the normal recovery by panicked sellers.
- davidw 18y ago
  Here's a question for the quant-minded: > So I'd be looking for value stocks that have a P/E ratio that's overly low The thing that makes me nervous about that kind of thing is that there are people who have written code that knows a lot more than my sum total knowledge of the stock market to look for those sorts of factors. Given actors like that, is there any reason to invest in anything but broad index funds?
  - DanielBMarkham 18y ago
    I believe there is. The criteria I mentioned would just be the start of the search -- you should easily come up with scads of stocks that meet that criteria. There are a lot of steps after that. Going to an index is usually a safe bet. I think it still is. But that's long term. You could end up waiting ten years just to double your money. I'm just talking about a quick hit. Now you could combine the approach and go with an sector index. But the more you spread it out the more of a slow response you're going to get, in my opinion.
  - mixmax 18y ago
    A friend of mine works for a small company that develops the models that many automated tradings are based on. It's so secret that he won't even tell me which companies use the software, only that it's some of the major global players. He does tell me about the software in broad terms though, and it is obvious there is a market for a new player in there. Basically almost everyone is using the same models and algorithms, just with different tweaks. And it's based on 20 year old principles. Start writing code that looks for different patterns (weather, psychological factors, etc.) and you might be able to beat them.
    - davidw 18y ago
      > The effect of the sun seems to have been quite big. For shares traded in New York, for instance, annualised returns on perfectly sunny days averaged 24.8%, compared with 8.7% on perfectly cloudy days. Moreover, unlike some stockmarket “anomalies” discovered by economists, investing by the sun would have been more profitable than simply investing in the market index, even after subtracting trading costs. Alas, this does not guarantee profitable trading in the future. Even assuming the effect really exists, investors, now they have been alerted to it, will probably arbitrage away any excess returns to be had by exploiting it. http://www.economist.com/finance/displaystory.cfm?story_id=E1_RNQSDS http://www.economist.com/finance/displaystory.cfm?story_id=E... So... it seems as if people really do think of everything - why wouldn't they, with millions or billions on the line. What hope does an individual have?
      - mixmax 18y ago
        What hope does an individual have? More than you think. Especially if you change your attitude towards the problem a bit ;-)
        davidw 18y ago
        My attitude is that it's pretty clear how I can take on (or rather, simply run around) even big players as a small startup. It's less clear how I can come out ahead stock picking as an individual. So it's better to not dick around with stock picking, put my money in cash (like it has been for a while), or an index fund, and just concentrate on the startup stuff.
  - nostrademons 18y ago
    I worked for a financial software startup from 05-07, and in my spare time there, wrote one of those programs that scans the whole market for stocks with low P/Es and consistent earnings. I found that nearly everything was fairly valued. When a stock had a low P/E, it was nearly always for a reason, like it being a homebuilder or financial or having a shaky economic position. No way was I going to invest in those. When I did invest in one that looked like it didn't fit in those categories, they missed earnings the next quarter, reported a loss, and haven't gotten back to profitability yet. Again, the market was smarter than me. The trick to making money in the stock market seems to be to invest when the big boys are constrained not to. They realize that they should be putting money in, but can't, for whatever reason. The best example is if they're a mutual fund and their clients are all pulling their money out. Doesn't matter how many bargains are out there, they still have to sell to honor redemptions. As I tell one of my hedge-fund-employee friends, "You're only as smart as your dumbest creditor."
    - mattmaroon 18y ago
      We're in an unusual time period. People (especially the big funds) are right now being driven by incentives other than maximizing expectation, which is creating an oversupply of stock and pushing down prices. Fear is, for the moment, outweighing greed.
    - 13ren 18y ago
      Another constraint on institutional investors is short-term profitability: they need to report annually, to compete for customers; whereas an individual is free to invest for the long-term.
    - furiouslol 18y ago
      An almost risk-free way to money in the stock market is to put most of your money in fixed income while apportioning a small % in long dated options. Eg. you think Morgan Stanley is dirt cheap at current levels ($10) and you are willing to invest $100,000 in them. Action 1: You bought $100,000 worth of MS shares at $10 each Action 2: You bought $90,000 in bonds that yields 11%. You bought $10,000 worth of Jan 2010 MS 5 call options at $7 each. Scenario 1: MS gets nationalized or goes bankrupt Action 1: You would have lost almost all of your $100,000 investment. Action 2: If you hold out until your bond mature, you'll get back your $100,000 principal after 1 year. Your options is worthless. Scenario 2: MS goes up to $30 Action 1: Your investment is now worth $300,000 Action 2: You get $100,000 from your bonds and your $7 options is now worth $18. So your investment is worth $125,000. So Action 1 is very volatile and risky. Your profit range from -100% to 200%. Action 2 allows you to sleep soundly at night, even during current market conditions. Your profit range from 0% to 25%. Hey not bad at all. In the worst case, you'll have at least preserved your capital.
- furiouslol 18y ago
  There's a reason why those trailing P/E are lows. The E will decrease drastically in the future. You have to make really good guesstimate on what the E will be in the future before you can determine whether it is cheap. There's a lot of danger in picking stocks based on P/E. You have to look at their debt ratios and short term financing requirements. You should avoid highly profitable firms that use crazy leverages in achieving these high returns.
  - SwellJoe 18y ago
    Cash (cashflow and cash on hand) is king in times like these.
fallentimes 18y ago
Do you happen to recall the historical P/E averages?

DanielBMarkham 18y ago

Usually during a re-adjustment the market swings too far the other way by a few points. So I'd be looking for value stocks that have a P/E ratio that's overly low. Find some stock that's getting beaten up beyond the normal recovery by panicked sellers.

davidw 18y ago
Here's a question for the quant-minded: > So I'd be looking for value stocks that have a P/E ratio that's overly low The thing that makes me nervous about that kind of thing is that there are people who have written code that knows a lot more than my sum total knowledge of the stock market to look for those sorts of factors. Given actors like that, is there any reason to invest in anything but broad index funds?
- DanielBMarkham 18y ago
  I believe there is. The criteria I mentioned would just be the start of the search -- you should easily come up with scads of stocks that meet that criteria. There are a lot of steps after that. Going to an index is usually a safe bet. I think it still is. But that's long term. You could end up waiting ten years just to double your money. I'm just talking about a quick hit. Now you could combine the approach and go with an sector index. But the more you spread it out the more of a slow response you're going to get, in my opinion.
- mixmax 18y ago
  A friend of mine works for a small company that develops the models that many automated tradings are based on. It's so secret that he won't even tell me which companies use the software, only that it's some of the major global players. He does tell me about the software in broad terms though, and it is obvious there is a market for a new player in there. Basically almost everyone is using the same models and algorithms, just with different tweaks. And it's based on 20 year old principles. Start writing code that looks for different patterns (weather, psychological factors, etc.) and you might be able to beat them.
  - davidw 18y ago
    > The effect of the sun seems to have been quite big. For shares traded in New York, for instance, annualised returns on perfectly sunny days averaged 24.8%, compared with 8.7% on perfectly cloudy days. Moreover, unlike some stockmarket “anomalies” discovered by economists, investing by the sun would have been more profitable than simply investing in the market index, even after subtracting trading costs. Alas, this does not guarantee profitable trading in the future. Even assuming the effect really exists, investors, now they have been alerted to it, will probably arbitrage away any excess returns to be had by exploiting it. http://www.economist.com/finance/displaystory.cfm?story_id=E1_RNQSDS http://www.economist.com/finance/displaystory.cfm?story_id=E... So... it seems as if people really do think of everything - why wouldn't they, with millions or billions on the line. What hope does an individual have?
    - mixmax 18y ago
      What hope does an individual have? More than you think. Especially if you change your attitude towards the problem a bit ;-)
      - davidw 18y ago
        My attitude is that it's pretty clear how I can take on (or rather, simply run around) even big players as a small startup. It's less clear how I can come out ahead stock picking as an individual. So it's better to not dick around with stock picking, put my money in cash (like it has been for a while), or an index fund, and just concentrate on the startup stuff.
- nostrademons 18y ago
  I worked for a financial software startup from 05-07, and in my spare time there, wrote one of those programs that scans the whole market for stocks with low P/Es and consistent earnings. I found that nearly everything was fairly valued. When a stock had a low P/E, it was nearly always for a reason, like it being a homebuilder or financial or having a shaky economic position. No way was I going to invest in those. When I did invest in one that looked like it didn't fit in those categories, they missed earnings the next quarter, reported a loss, and haven't gotten back to profitability yet. Again, the market was smarter than me. The trick to making money in the stock market seems to be to invest when the big boys are constrained not to. They realize that they should be putting money in, but can't, for whatever reason. The best example is if they're a mutual fund and their clients are all pulling their money out. Doesn't matter how many bargains are out there, they still have to sell to honor redemptions. As I tell one of my hedge-fund-employee friends, "You're only as smart as your dumbest creditor."
  - mattmaroon 18y ago
    We're in an unusual time period. People (especially the big funds) are right now being driven by incentives other than maximizing expectation, which is creating an oversupply of stock and pushing down prices. Fear is, for the moment, outweighing greed.
  - 13ren 18y ago
    Another constraint on institutional investors is short-term profitability: they need to report annually, to compete for customers; whereas an individual is free to invest for the long-term.
  - furiouslol 18y ago
    An almost risk-free way to money in the stock market is to put most of your money in fixed income while apportioning a small % in long dated options. Eg. you think Morgan Stanley is dirt cheap at current levels ($10) and you are willing to invest $100,000 in them. Action 1: You bought $100,000 worth of MS shares at $10 each Action 2: You bought $90,000 in bonds that yields 11%. You bought $10,000 worth of Jan 2010 MS 5 call options at $7 each. Scenario 1: MS gets nationalized or goes bankrupt Action 1: You would have lost almost all of your $100,000 investment. Action 2: If you hold out until your bond mature, you'll get back your $100,000 principal after 1 year. Your options is worthless. Scenario 2: MS goes up to $30 Action 1: Your investment is now worth $300,000 Action 2: You get $100,000 from your bonds and your $7 options is now worth $18. So your investment is worth $125,000. So Action 1 is very volatile and risky. Your profit range from -100% to 200%. Action 2 allows you to sleep soundly at night, even during current market conditions. Your profit range from 0% to 25%. Hey not bad at all. In the worst case, you'll have at least preserved your capital.
furiouslol 18y ago
There's a reason why those trailing P/E are lows. The E will decrease drastically in the future. You have to make really good guesstimate on what the E will be in the future before you can determine whether it is cheap. There's a lot of danger in picking stocks based on P/E. You have to look at their debt ratios and short term financing requirements. You should avoid highly profitable firms that use crazy leverages in achieving these high returns.
- SwellJoe 18y ago
  Cash (cashflow and cash on hand) is king in times like these.

fallentimes 18y ago

Do you happen to recall the historical P/E averages?