Monday, October 20, 2008

Taking Advantage Of Shifts In Market Sentiment

Every few years or so the market gets pessimistic on stocks and individual companies go on sale at depressed levels. But how can investors tell if pessimism is high enough to warrant a purchase of a particular stock? In The Investment Zoo, Stephen Jarislowsky suggests looking at a company's historical P/E over time in order to determine whether a stock is relatively cheap.

As an example, here's a look at Coke's (KO) P/E over the last several decades:

We can clearly see that the market is currently quite pessimistic on this stock relative to its history. We can also see what a great bargain this brand name company was in the early 80s when stocks were quite unpopular.

Of course, this is far from a perfect method to determine if a stock is cheap. As companies transition from start-ups to growth companies to mature companies, one would expect that the company's appropriate P/E would actually change over time.

Furthermore, just because a company's historical P/E has traded within a certain band does not mean that will continue into the future. You still have to ensure you understand the company's situation (including its financial statements) before jumping in. Nevertheless, an examination of this nature can help identify stocks that may be oversold and thus warrant further analysis.


Anonymous said...

Interesting post.
Question: Where can I find the historical P/E ratio of a company going back a couple of decades?
Could you give me a couple of links to websites that provide this data?
Jeroen Berendsen, Amsterdam
PS: I love your blog, keep it up!

Saj Karsan said...

Thanks Jeroen!

You may have to construct the P/E values yourself. On Google Finance you can find the P portion going back several years. The E can be a bit more challenging, but for the enterprising investor it can be found by going through old annual reports as far back as one is interested! Of course, some online databases (e.g. Compustat) also provide this data but require subscriptions.

Anonymous said...

regarding historical PEs, Thomson Datastream provides great times series for actual Earnings, as well as for forecasted Earning (IBES estimates). Unfortunately, Datastream is not cheap.
Does anyone know where else one can get historical IBES estimates? thanks!

Unknown said...

Barel, your blog is getting better by the day. Outstanding.

I would reccomend some comparative analysis of historic P/Es (vs PEP for example that I find cheaper than KO).

I was trying to get information on bottlers too. I konw where too start now. Lots of activity in that arena.

Saj Karsan said...

Thanks for the kind words, Matias.

I'll take a look at those when I get a chance.

Anonymous said...

This analysis is good idea but has a severe drawback. Walgreens is now a mature company. So there is not much to expect in terms of fututer growth in earnings. So we really cannot compare its current P/E Vs its P/E twenty years in the past. Such comparisons are incorrect. You could however, compare the P/E of a company now with its P/E say 3 years back. That makes more sense.

Saj Karsan said...

Hi Anon,

I assume you mean Coke, since that's the article you commented on? You're right that growth expectations do factor into P/E values, but it is not the only factor: note that despite being a smaller company 30 years ago, Coke's P/E was still lower than it is today due to other factors (e.g. market sentiment).