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To: jbe who wrote (21237)	5/3/1998 5:56:00 PM
From: Chuzzlewit	Read Replies (1) \| Respond to of 95453

jbe, you raise an interesting point (and have pushed one of my hot buttons). P/E is meaningless for a variety of reasons. First, it is backward looking. If it were to mean anything, it would need to focus on the future. Second, it ignores the discounting feature of the market place. Nowhere is the p/e "normalized" in relation to the long-term interest rate when people talk historic P/Es. Third, it is a single period number -- based on a quarter or a year -- not the lifetime of the company. Finally, the very concept of "earnings" is misleading. Earnings and profits are illusions created by accountants. I'm not dumping on accountants, but they really need to develop better accounting standards. Sadly, current accounting standards are confusing to many, including professionals. Look at the havoc wrought by the change in accounting standards for the software industry. The new standard called for a much more conservative approach in recognizing software sales. As a result, a number of ERP companies stock prices dipped dramatically in spite of the fact that nothing other than the accounting standard had changed. Not only sales, but depreciation rates, expense allocations, recognition of liabilities -- all of these are estimates by management based on flexible accounting standards. As a result, earnings may vary widely depending only on the accounting practices followed. Ultimately, reported earnings depends on the subjective judgement of management and accountants. OXHP is a great study on how earnings can be misleading. Price to sales is even worse, because it neglects all of the important parameters that drive the price of a stock. It might be marginally interesting as a coincident parameter, like hemlines or what team wins the Superbowl, but I don't believe it is very good as a valuation foundation. For example, supermarkets have high turnover (which means high relative sales) and low profit margins. Consequently, they have low PSRs. Compare that to an oil rig fabricator to see what I'm talking about. That's why I like to watch operating cash flow as the most important parameter of a business. To calculate it, take operating earnings before taxes and interest, add non-cash charges such as depreciation and amortization. Subtract increases in A/R and inventory and that gives you the base number. Depending on the kind of industry you're in you might want to tweak it further. The larger question is one of valuation. Theoretically, the value of a business will be the present value of its stream of future free cash flows. The problem is that we have a limited horizon, and no decent metric to quantitate the risk in those future cash flows (i.e., standard deviation). These issues (along with a host of others) lead people to embrace the concepts of MPT. Well, I seem to have rambled on and on, so I'll stop here. TTFN, CTC