What should I do now with stocks that have high P/E?
Can I buy and sell stock based on P/E?
P/E is the simplest indication if a stock is too expensive.
P/E stands for Price/EPS (Earning per Share).
Notice that it is earning per share, not pure earning, or true value.
EPS = E/S. One can increase EPS by reducing the number of shares.
In the past few years, the CEO’s and the board of directors, who benefitted directly from higher stock prices, have been more than happy to increase EPS, by buying back their companies’ shares. According to Bill Gross, in recent years, U.S. corporations have spent more than $500 billion annually on buybacks.
Trump proposed tax cut and tax holiday to repatriate the money, hoping that the corporations will bring jobs back to the US. However, during Bush-era’s tax holiday, most of the hundreds of billion repatriated was spent on dividends, corporate bonuses and stock buybacks.
So, what may happen, if the market is flooded with more money and less shares?
EPS (earning per share) will increase.
But actual E (earning) may not.
The P (price) or stock market may increase.
But the economy (value) may not.
The P/E may remain high, and the economy may not grow.
This will very likely lead to inflation.
The salary may increase in some segment or area.
But the actual buying power of the working class may decrease.
It could lead to short term prosperity but long term chaos.
The government created huge inequality, by using QE to contain the bubble.
Now, it seems the new government will try to ease the inequality by creating a much bigger bubble.
For ordinary people like us, what should we do?
Back to fundamental. Don’t panic. Don’t gamble.
Let’s look at some of the big names, or companies that might be classified as Stalwarts by Peter Lynch: K (Kellogg), V (Visa), KO (Coca-Cola), BMY (Bristol-Myers Squibb), GE (General Electric), and CL (Colgate-Palmolive).
First, look at the monthly charts: Aren’t they pretty? Almost perfect ascending channels since 2009, until recently. These stocks enjoy several good years. The market gave you plenty of opportunities to earn with these stocks for year.
Now, let’s take a closer look and check the weekly charts. What happens? Some are going down.
Let’s zoom in even closer by checking the daily charts, some really went down recently.
All these companies are very big. It is unlikely that their E (earning) will grow or reduce fast. Why their prices could go 2x, 4x, or even 8x in 7 years? Why some of them are down now?
Let’s re-exam P/E.
Some of these stocks have P/E above 40. As pointed out in The Buffettology Workbook, when P/E is higher than 40, it would take a longer time to recover once the market starts its major correction.
But could we use P/E alone to decide when to sell? The simple answer is no.
Notice that, many of the stock have high P/E for a long period of time. As mentioned, this might be due to the reducing of shares to increase EPS, and the printing a lot of money to chase after the reduced amount of shares. So, if you simply look at P/E and decided to sell before the market starts correction, you’ll hate yourself for selling too early, and worse yet, you may bought back at the highest point, if you can’t read the price movement at all.
Earning Channel is automated channel finder and channel trader.
Channel is the simplest and accurate way to track the price movement. A channel is formed when the price movement forms is a wave within two parallel lines. When you spot a channel, you can gradually build a position, buy and hold, till the ascending channel breaks. For down market, or bad companies, you can also short and hold, till the descending channel breaks.
Back to those stalwarts.
What should I do, if I have some of them?
What if I don’t have any? Could I buy now? Can I short?
Trump’s policy may make the bubble bigger. So, the price might keep high or go higher. Therefore, it is not safe to short these kind of companies.
The underlining economy is not good, that’s why people are angry, and Trump got elected. Can these companies keep their growth fast enough to deserve high P/E? If not, don’t buy. It is not safe to buy and hold for companies with high P/E.
Price and fundamental
Remember – buy and hold . . . till the channel breaks. If the channel is not broken, stay with it, but you can reduce position. If the channel is broken, especially if the monthly channel is broken – Clean and Stay Away. Sell some, at least.
Like Peter Lynch said, be flexible, and change to whatever has better return. Go and look for better candidates that will bring you profit, those that have channels and matching fundamentals. Earning Channel can help you find these candidates for long or short positions.
Though overly simplified, the above are rules of thumbs for you to prevent from getting panic, or becoming a big risk taker in uncertain time.
Good luck on your investment!