JPR, perhaps the best way to view this is to invert the ratio so that you get a yield (i.e. earnings/price). Now it should be intuitive that the yield ratio is sensitive to several things.
1. Just as in bonds, when inflation is low, yields tend to be low (remember, yield is just inverted p/e, so a low yield implies a high p/e).
2. Just like CDs, yields will vary reflecting a changing environment, but unlike CDs, yield are backward looking. Nobody would invest in a CD based on last year's yield, but that is precisely what they do when they base their decisions on p/es. But it is worse than that. If you were going to be consistent you ought to at least use last year's price to calculate the yield. For Dell that would be somewhere around $50, and then you would use the earnings in the next four quarters to calculate the yield.
3. But these yields are not static. Dell's yield is expected to increase by virtue of earnings growth. This means that investors will pay more (i.e. accept a lower current yield) in anticipation of future yield increases.
4. Finally, the marketplace is competitive, so yields on stocks compete with yields on bonds. Obviously, when bond yields drop, so do stock yields.
Now I use a metric that I call CNPEG to measure the relative price oc growth. The way it works is to calculate the PEG (which is the ratio of the P/E to the expected long-term growth rate) for the stock you are examining and the PEG for the market (I use the S&P500). I divide through by the PEG for the market, and this tells me whether the stock is relatively undervalued when normalized for the market. CNPEG stands for "Chuzzlewit's Normalized PEG". A CNPEG of less than 1.00 indicates relative undervaluation.
TTFN,
CTC |
