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To: Michael Collings who wrote (47824)	4/24/2000 1:07:00 AM
From: AllansAlias	Respond to of 99985

Michael, Nice post. That is just about the most succinct discussion of P/E's that I have seen. NASDAQ futures way down as I type, but it's early yet. Listen all, I noticed something tonight when I was reviewing my index charts. As you know, most of them had their intermediate-term trendline redefined in Oct/99. Specifically, one could draw a line from the terrible lows of Oct/98 to the lows of Oct/99. Most every index has violated this trendline sometime since Dec/99. That's no surprise. However, I notice that the S&P 400 has not. Any thoughts on this anomaly? G'nite --Allan

To: Michael Collings who wrote (47824)	4/24/2000 10:21:00 AM
From: TheKelster	Read Replies (1) \| Respond to of 99985

Thanks for the refresher course. Excellent job of compressing the pertinent info into a nutshell.

To: Michael Collings who wrote (47824)	4/24/2000 4:19:00 PM
From: HairBall	Respond to of 99985

Michael Collings: Congrats your post made the "cool posts list" on the SI home page. Regards, LG

To: Michael Collings who wrote (47824)	4/25/2000 2:04:00 AM
From: FR1	Read Replies (2) \| Respond to of 99985

Regarding your discussion of PE: I have always wondered about the PE model. Let's suppose that we all went by the PE model you mentioned. Most people, of course, would want to invest in the best businesses. So in a very short period of time the big names like GE, CSCO, etc would have enough investments from the public to make their PE saturated. In other words, if GE was growing at a 15% rate it would get to a PE of 15 very quickly. Further investments in GE should not be made because they can not match a higher PE. What happens then? Where would all the investors of the world (which are growing rapidly) go with their money? 5% savings account? It seems to me that the PE system works great if you have a small number of investment businesses that control most of the available money to be invested. They can make sure everybody gets their share of GE stock and investments stop around a the PE of 15. Perhaps this is the way it used to be. If the PE of every stock was limited to its growth it would be nice, in a way, because we could calculate the amount of money that could be given to a business and simply have automatic "freezes" on stock ownership once the PE was hit. People could be on the "waiting list" for a stock. The problem is that fund managers would have every share of GE tied up plus the waiting list. I don't think the system we currently have is all that good but a strict PE system seems very limited.

To: Michael Collings who wrote (47824)	4/25/2000 10:24:00 AM
From: WTMHouston	Read Replies (1) \| Respond to of 99985

Michael: Great post. The attention to value, as measured by growth against price, is long overdue. That said, I do not understand how "new economy" stocks with astronomical PEs can be reasonably considered without also evaluating and considering the companies with much lower PEs. I am particularly amazed given the recent trend towards the market's (stated) desire for "value." How about a stock with TTM ROE of 37.09, TTM ROA of 19.44, TTM ROI of 30.82? How about average sequential quarterly (not annual) EPS growth for the last six quarters of 57%? The last 4 quarters EPS (Q1-Q4 1999) increased 51%, 36%, 42%, and 30%, respectively. This company will report earnings on 4-27 and is likely to report year-over-year revenue growth of over 50% and EPS growth of over 200%. How about: better than 55% below its 52 week intraday high and just over 50% below its 52 week closing high? This is not a micro cap company: it had revenue in FY1999 of $383M and currently has a market cap of just over $2 billion: but, it has NO analyst coverage. This company also has a VERY small float: just under 6 million shares. This company earned $2.21 per share in FY1999 and is likely to exceed $5.00 EPS in FY2000 and $8.00, conservatively, in FY2001. It current stock price is around $71 a share. Let's see: that is a current TTM PE of around 32. If they report at least $1.03 in the next couple weeks, which is conservative at 25% sequentially above Q4 1999, the PE on Q1's annualized EPS is around 17. If it earns $5.00 this FY, it is currently trading at around 14 times FY2000 EPS and around 9 times FY2001 EPS. Price to Cash Flow is 1/3 less. If this does not spell value -- based on traditional valuation methods -- with a capital V, nothing does. Have I mentioned that this company has NO LT debt and has a (TTM) Gross Margin of over 41%, an Operating Margin of over 24%, and a net Profit Margin 17.31%, all of which have been increasing sequentially. This company will also be doubling capacity this fiscal year. One final tidbit: its largest non-insider shareholder is Fidelity. The company is Siliconix (NASDAQ:NM -- SILI). Briefly, it "develops, produces and markets power and analog semiconductor components for the computer, data storage, communications, and automotive markets." In particular, its bread-and-butter is Power MOSFETS, which are used in EVERY cell phone (and other wireless devices) in the world. SILI is 80.4% owned by VSH, which accounts for the small float and lack of analyst coverage. MOT is a major customer of SILI. The only major cell phone maker in the world that is not a SILI customer is NOK, but NOK is a major customer of VSH -- thus, there is speculation that NOK may soon become a SILI customer. Do I own it? Sure (and at a price well below its current price). Would I love to see it get more attention? Sure. But, at least as much, it still amazes me that in this day and time of a search for value (or at least a time when the market has "corrected" because too many companies are perceived as and are overvalued), there is not more coverage of and attention to companies such as SILI that represent incredible "value." Cynically, I speculate that since analysts don't cover it, no one else will either. Maybe there will come a time soon when the talk about wanting "value" in stock prices is more than just talk. We can only hope. Troy PS - this was not initially intended as a spam of SILI, although I recognize that it turned into it a bit.

To: Michael Collings who wrote (47824)	4/27/2000 8:52:00 AM
From: GVTucker	Read Replies (5) \| Respond to of 99985

Michael, RE: P/E's have always been a way to evaluate the merits of an investment. Stocks trade at a multiple of earnings and take into account future earnings. The old rule was that the P/E should reflect the company's growth rate, ie., if a company was growing at a 20 percent growth rate, then a p/e of 20 to 25 was in line with fair value. In bull markets the p/e might go higher and in a bear market the p/e might go lower. Along the same lines was the E/P, ie., the actual return on investment. A company earning $1 and trading at a price of $15 (a p/e of 15) was returning 6.66%. I would disagree with this premise. Perhaps I am going beyond the scope of your initial desire to have this be Investing 101, but nevertheless I think it is important to think of the relationship of earnings growth and expected return. Even more so than PE, expected return has completely fallen off the map as a tool of investment analysis. Let's look at a company similar to your example, a company that is growing earnings at 20% a year. If the prospect of this earnings growth if unpredictable and risky, as has been the historical case of a company with earnings growth this high, you would indeed possibly see the market expect a return of, say, 20% a year. In this case, the PE of the stock would indeed be 20. In the past two decades, we have seen companies that have appeared to have been able to sustain high earnings growth for much longer than anyone thought possible. Now we can get into a long discussion about how predictable or risky an earnings stream growing at 20% might be--high preditability/low risk growth streams like KO or MSFT have proven to be a little more risky than previously thought--but it is certainly very reasonable to conceive of a company with 20% earnings growth but much lower return expectations. If we say the the expected return of the company is closer to 10%, and earnings growth is 20% for the next 10 years and then drops to 10% (just to make the calculation easier) then you would see the PE on the company at 23.9. This calculation assumes that you have a 10 PE in year 10. While this is still within the range of PE's you gave, you can quickly get out of that range when you look at a company like CSCO. Here, if you assume market expectations parallel Wall St. expectations (a rather extreme leap, for sure) then the long term earnings growth rate for CSCO is 30% (a premise that I don't agree with, but will use, given that it is the market's expectations). Given that the market thinks that CSCO's growth rate is highly predictable and also not risky (in spite of what you or I might think), an expected return of 10% isn't unreasonable. Now, to work the numbers, let's say that CSCO grows at 30% for 10 years and 20% for 10 years and 10% thereafter. This would translate to a current PE of 127. Here's the math. I am using CSCO's current year earnings of $1 to make the numbers easy. Yr 0 earnings: $1 Yr 10 earnings: $13.79 (10 yrs of 30% growth) (math: 1.3010 x 1) Yr 20 earnings: $85.36 (10 yrs of 20% growth) (math: 1.2010 x 13.79) Price at yr 20: $853.58 (PE of 10 with exp. ret. of 10%, growth of 10%) Discount Price at yr 20 back 20 yrs at 10%: $126.88 (math: 853.58/(1.1020) Or, if earnings were $1 now, a PE of 126.88 I am not saying that the price of CSCO is reasonable to me, only because I think the assumptions outlined above are highly, highly optimistic. I am only stating this to give an example of how the current price can be justified using the old line ratios that we have all been taught to know and love. In addition, I think that a lot of people may have misunderstood your comparison to a government bond yield. Please don't mistake this to assume that I think that you don't know what you're talking about, as it is pretty clear that you do. Rather, I think that a lot of people have misunderstood your statements, given a few private emails to me. To me, the government bond yield is relevant mainly in assigning an expected return to a stock. Indeed, if, as stated in your example, you wanted to have the expected return of CSCO be equal to that of a govt bond in year 10, that would make the current PE even higher. The higher the government bond yield, the higher the expected return for a stock. Investing 101. For me, the riskiness of the cash flows of a stock would demand a higher expected return than the govt bond. Of course, if you buy the new paradigm, then the expected return of the stock market should actually be less than** the government bond yield. That is a whole 'nuther argument. Do I still that the market (i.e. the S&P 500) is still highly overvalued? Most definitely. But don't extrapolate that to assume that the current bulls have no quantitative basis for their bullishness. They do. I (and I would suspect you also) would just disagree with their premise.

To: Michael Collings who wrote (47824)	4/30/2000 2:17:00 PM
From: John Malloy	Respond to of 99985

I would like to offer some comments on your recent discussion of P/E ratios. The P/E ratio is an empirical measure. The "typical" P/E ratio only makes sense when applied to a "typical" stock. Today's high-tech firms growing 40, 50, and 60 %/yr. are hardly typical. "Typical" P/E ratios do not apply to them. The basic measure of what a stock is worth is the present value of all the cash that flows into an investor's pocket as a result of buying a stock. The original dividend discount model was developed for a firm growing at a constant percentage rate. That model is OK for a stable, mature firm growing at a moderate rate. It is reasonable to assume that moderate growth rates will stay constant. It is not reasonable to assume that high-tech firms growing 40, 50, and 60 %/yr. will continue growing at those high rates forever. Some allowance must be made for slowing growth. A common assumption like "5 years at 50 %/yr. followed by 5 years at 25 %/yr., and 10 %/yr. from then on" is too crude for my taste. I have worked out a better way to forecast that provides unlimited flexibility. Forecast growth rates by drawing a free-hand forecast curve on a sheet of graph paper. You can twist and turn the forecast curve any way you think best describes how growth will slow. That curve can be translated into a quantitative, dollars-and-cents value for the stock. I recently used this procedure to value Cisco, which was selling at a P/E near 200 at the time. I made what I thought were pessimistic assumptions about how fast Cisco's growth would slow and how fast the price/book ratio would drop as a consequence of the slowing growth. The analysis was based on growth gradually slowing from 48 %/yr. now to 28 %/yr. in five years, and the price/book ratio falling from 30 to about 14 as a result of the slowing growth. That analysis showed that an investor could pay $76 for Cisco and still earn a target 15% after-tax return. Cisco was selling for $73 at that time. That analysis said Cisco was fairly priced, even at a P/E near 200. I have written a paper on the Cisco analysis and would be happy to send a copy if you are interested. There is also a description of using the procedure to value Microsoft on my website, www.analyticalbooks.com John Malloy