jwp@uwmacc.UUCP (Jeffrey W Percival) (03/12/86)
Someone mentioned that the stock market is just a present value machine. This can't be totally true, because then every stock with a given P/E ratio would sell at exactly the same price, right? A quick glance at the stock listings shows this not to be the case. Comments? -- Jeff Percival ...!uwvax!uwmacc!jwp
jbt@burl.UUCP (jbt) (03/15/86)
In article <2023@uwmacc.UUCP> jwp@uwmacc.UUCP (Jeffrey W Percival) writes: >Someone mentioned that the stock market is just a present value machine. >This can't be totally true, because then every stock with a given P/E >ratio would sell at exactly the same price, right? A quick glance >at the stock listings shows this not to be the case. Comments? > >-- > Jeff Percival ...!uwvax!uwmacc!jwp Present value, as I understand it, represents the current value of the stream of future payments over time, as in dividends and capital gains from a given stock. A price to earnings ratio is simply a snapshot of a company's P/E ratio. This ratio can be historic, current or projected to some time in the future, depending on what use is to be made of it. There seems to be only an indirect relationship between P/E ratio and the concept of a stock (market) as a present value machine. Comments encouraged! es---------- <<I speak only for myself and the thoughts(?) are mine--my wife says so>> Jack B. Turner, Planning Engineer EMSP Project, AT&T Federal Systems Division Burlington, NC Phone - 919/228-4321 (Cornet 291) Usenet- ![ ihnp4 ulysses cbosgd mgnetp ]!burl!jbt
kapil@dartvax.UUCP (Kapil Khetan) (03/16/86)
>Someone mentioned that the stock market is just a present value machine >This can't be totally true, because then every stock with a given P/E >ratio would sell at exactly the same price, right? A quick glance >at the stock listings shows this not to be the case. Comments? > > Jeff Percival ...!uwvax!uwmacc!jwp Correct me if I have misunderstood your question, but what you are getting at is "if the stock market is a NPV machine then companies with a certain earning should have the same price, therefore producing the same P/E ratio." You have not taken into account the other component of NPV besides the cash flows (earnings), and that is the rate to discount them at. This rate depends on a lot of factors especially, the company's financial structure, the industry it is in, it's past earnings record and so on. The Capital Asset Pricing Model gives an indication of the discount rate if the following are known: the company's beta, the rate of return for a risk-free rate, the rate of return for a market portfolio. It simply says, the more volatile the stock (beta) the higher the discount rate. This is why Treasury Bills have a very low return (being safe and non-volatile) and stocks in hi-tech companies are discounted at high rates. Thus you might notice that IBM has a very high P/E multiple. This is because it is safe and is not very volatile (the beta should be just slightly higher than 1.0). On the other hand a high-tech company will not have a very high P/E ratio. (You didn't think I would call IBM a high-tech company, did you?) Kapil Khetan kapil@dartvax.UUCP kapil%dartmouth@csnet-relay.ARPA kapil@dartmouth.CSNET Mummies: Egyptians pressed for time
jwp@uwmacc.UUCP (03/19/86)
What I was mostly getting at was this (and I'll phrase it as a question): Are there at least two companies on the NYSE with the same expected earnings (over some reasonable time) with the same beta, with the same everything else, except that they sell at different prices? I am shooting from the hip on this one, but I would be surprised if something unrelated to the present value calculation (like demand, or trendiness) was not important in setting the price of a stock. Stock prices are set by people, not computers. See what I'm getting at? Is every number published in the NYSE section of the WSJ the result of a numerical calculation of present value, based on reasoned and researched values of expected periodic payments and a discount rate based on solid research by knowledgeable investigators? By the way, what's the "N" in the "NPV" mentioned in an earlier article? -- Jeff Percival ...!uwvax!uwmacc!jwp
raha@sphinx.UChicago.UUCP (Bob Hettinga) (03/19/86)
There are several reasons that P/E ratios would not be directly related to price. The most important are: 1. Earnings could be in the form of a one time shot of cash from somewhere; 2. The earnings figures could be cooked -- some people use some pretty sophistic tax dodges, like changing inventory methods -- and the more experienced investors are discounting the information in the price of the stock; or, 3. the market sees the impact of something coming (the old saw: [buy/short] the rumor, [sell/buyback] the news). I tend to look at P/E's as more of a psychological indicator than anything else. If a company's making so much money (low P/E), why is the market so down on it? I like to screen for low P/E s , then see what the story is. If I believe the story, I stay away. If I doubt it, I set up my decision rule for selling, and then I buy the stock. I now see all you efficient market hacks out there gagging. This is a classic stock picking strategy called bottom fishing. It's a variant on the old Graham and Dodd trick of buying value. At first glance, low P/Es seem to represent a hole in the Efficient Market Hypothesis big enough to drive a truck through. It seems that a proffessor at Michigan used CRSP tapes to check out Ben Graham's Intellegent Investor strategy (buy if the stock has a low P/E and is selling below Book Value). It turns out that while buying stocks with book values below share price will not give you returns above the market (in fact, in his case, he got yields *lower* than the market), buying stocks with Low P/E ratios will in fact give you give you above market returns. Not outrageous returns, but more than the market will give you. Conceptually, this all makes sense. After all, what's the book value of a Mexican oil loan these days, or US Steel's South Works? You can bet neither has been completely written down yet, though both are worth a lot less than the accountants say they're worth. P/E ratios seem to me to represent the current state of the rumor mill, or as the finance hacks around here like to say, the effects of the information in the market versus the information the company has on it's P&L. So, this really doesn't reflect anything nasty on the Efficient Markets Hypothesis. It's just that the market (please don't hit me) can be wrong. I know, that's like saying that the temprature outside can be wrong to some people. But the current temprature can change, just like stock prices, and some people like to try to predict their behavior :-). Yes, Virginia, the Market is a Big Present Value Machine. But value is transitory, illusory, and essentially someone's opinion... Unfortunately (fortunately?) the market values those 'opinions' in cold cash. Bob Hettinga (Sorry, I never could disclaim very well with rocks in my mouth) -- ___________________________________________________________________________ .....and then I woke up. ___________________________________________________________________________ Bob Hettinga Center for Continuing Adolescence !ihnp4!gargoyle!sphinx!raha NASA Contract Number : (wait a sec, ... I wrote it here someplace...)
luscher@nicmad.UUCP (03/20/86)
>Is every number published in the >NYSE section of the WSJ the result of a numerical calculation of present >value, based on reasoned and researched values of expected periodic payments >and a discount rate based on solid research by knowledgeable investigators? Of course not. The 'present value' theory states how people would value stocks if they had access to information that real people cannot possibly know and if they were what a professor would call rational. We all know people aren't rational (except perhaps me ;-). The numbers published in the WSJ tell what 'willing sellers paid willing buyers yesterday'. This obviously has little to do with present value. >By the way, what's the "N" in the "NPV" mentioned in an earlier article? The N is for Net. The net present value is the sum of the incomes (discounted) less the sum of the investments (discounted) necessary to produce those incomes. Corporations are assumed to exist forever - therefore your initial investment is never returned. By the theory, when you buy a stock you just purchase the value of the dividend stream. -- Jim Luscher / Nicolet Instruments / Oscilloscope Div. 5225 Verona Rd Bldg-2 / Madison Wi 53711 USA / 608/271-3333x2274