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Price / Earnings Hybrid Strategy

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by Grant Macdonald -  Jun 28, 2005
7.2 (from 20 ratings)

What else is required? Patience!

Let’s take a chart example.

XLF exchange traded fund (click to enlarge)


   

Here we have a monthly chart of a US banks ETF, and in late 2002 / early 2003, when banks were in the grip of the bear, the P/E (though not marked on the chart, unfortunately) was considerably <10,  signalling a screaming buy. Does the chart agree? I would say that it does, as by early 2003 there is an obvious, albeit wide, trading range in play and there was plenty of time to buy in this range before the subsequent uptrend. Remember that with no stop loss in place, the gyrations within the range would not have shaken us out of position.

At the time of writing, the P/E ratio is >11 and thus no longer fulfils our buying criteria. However, around $28, the P/E just qualifies and this coincides well with the approximate bottom of the chart consolidation pattern between $27 and $30, thus presenting another buying opportunity.

Unfortunately this example does not appear in the industry sectors that were compared and contrasted previously. However, as this is a current example as of June 7 2005, it will be very easy to track and monitor the results going into the future.

Real time examples are much more interesting than historical and hindsight examples, although from a research perspective they are vital as a starting point. This strategy is suitable for the risk averse trader or investor who requires higher than average returns, but with minimal risk and effort. It provides enough intellectual stimulation to keep you engaged with the market, yet avoids the often stomach churning adrenaline of the short term trader. All that remains is for the individual to test it in real time for themselves.

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Comment on this Article

Recent Comments:
blipper No I haven't had any luck via the internet either. Yes it was the Journal of Finance. I sourced my reference from originals, which was "Eugene Fama & Kenneth French" " The Cross-section of Expected Stock Returns" Journal of Finance 47 (June 1992) pp 427-465 There are many studies done in this field, I have work in which the results go back to the 1900's. The idea of diversification was not specifically referred to, or actively practiced by Fama & French, they simply...
ducati998   09-07-2005 20:40:37
Ducati Thanks for publishing your strategy which I find very interesting. Ive been looking for the article by F&F on the internet but no luck so far. Is it ' The Equity Premium' in which case I think it may only be available in the Journal of Finance of which Im not a member.? Im interested in their results as the main work on PEs Im familiar with is O'shaughnessey's 'What Works On Wall Street ' in which he looked at numerous strategies for the period 1951 to 1996. He took common...
blipper   08-07-2005 16:21:53
LION No, I realised you were referring to ttm earnings, I prefer Current earnings, or in your example the last full years earnings. So Dec 31 2004 Annual report, if looking at a company for analysis today. The reason that I am not terribly interested in Quarterly results are for the distortions that are manifest within the Income Tax, Working Capital, Surplus, Interest, Subsidiaries, and potential Off Balance sheet entities and Writedowns. These will all be disclosed in much...
ducati998   29-06-2005 17:36:06
Ducati, I am not talking about future/projected earnings. Company X has a 31 December end of year and you are analysing the company in September, do you use the 31 December figures or June to June? On the other hand, do you choose to exclude the prior half year and add in the new one? That is what I meant by - rolling PE ratios.
LION63   29-06-2005 17:16:57
the blades Psychological extremes are always a good place to be in the market. The P/E ratio is just a way of measuring the extreme to the downside, and going in the opposite direction. LION I personally prefer "CURRENT" rather than "ttm", and avoid "projected or future" P/E's, they are dangerous. cheers d998
ducati998   29-06-2005 17:05:17

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