ANALYSIS

HOW TO INTERPRET THE RATIO RESULTS*

LOW

A low value for the ratio that is below 15 or so can either indicate a good buy or a bad one depending on other factors. Strictly speaking a low value indicates a current stock price that is comparatively low compared to its earnings history.

MID-RANGE

A mid-range value for the ratio of roughly 15 - 25 generally indicates that the stock is currently priced accurately. Generally these stocks have not seen too much growth in recent years and will most likely continue this trend.

HIGH

A high value above 25 generally indicates that the stock is over priced in comparison to its earnings history. However in certain situations a high value simply means that within the last 10 years the stock has experienced high growth or is expected to in the near future.

It is trickier to measure a single stocks value utilizing the Shiller Ratio or CAPE Ratio then it is to simply measure if the market in general is overpriced or underpriced. An Index is comprised of many companies that are replaced over time as they become obsolete and worthless with new and better companies. Therefore while it is more or less safe to assume that a Shiller Ratio value of 10 for the S&P 500 would indicate that one should purchase on the Index the same is most definitely not true for individual stocks since they may suffer from poor management and could potentially be on the verge of bankruptcy.

 

The converse of the above statement with respect to individual stocks also undoubtedly holds true. Stocks with excessively high Shiller Ratio values may possibly be overvalued by current investors however at the same time the price may be correct even though it’s high with respect to previous earnings. Management might have vastly improved during the previous 2 - 3 years causing data from 10 years previous to be more or less irrelevant. Additionally market forces might have changed causing products and services offered by the company to now be in higher demand then previously.

 

As a rule of thumb a solid company that has been around for many years within a stable industry should yield a result of roughly 20 or within the range of 15 - 25. We see this with companies such as Ford, DuPont, Dow Chemical, IBM, etc... (Ticker symbols are FORD, DD, DOW, IBM).

 

However companies within rapidly expanding markets will generally have high ratio amounts considerably over 30 since EPS for prior years is less (examples are Google with ticker symbol GOOG). Companies to watch out for with high ratio values are the ones which often have a famous and lovable CEO and when the stocks are more often advertised then the services or products offered by the companies core business. When this is the case it could be that the stock is simply overvalued by collective misperception of investors.

 

Low values could indicate good buys from an investor’s perspective however it could also mean that the business is not doing too well. Dell (ticker symbol DELL) has a rather low value of roughly 9 for its ratio value. Since Dell is in the technology industry this could raise some red flags, however if management has a strong plan for correcting the course of the company it could easily be a good buy.

 

Within the banking industry which has been under siege as of late we can see some interesting ratio values occurring. Citibank (C), JP Morgan Chase (JPM), and Bank of America (BAC) make for an interesting comparison. Here we find rather low values for both Citibank and Bank of America. Perhaps this indicates that these two banks are good buys at the moment because they are certainly priced low in comparison to their respective earnings for the last 10 years. JP Morgan Chase who's leader has spent considerable amounts of time within the 'public-eye' on the other hand has a much higher value but still within a reasonable range suggesting that it might not be as good a bargain as Citibank and Bank of America but it is certainly a solid 'buy.'

 

For a much more academic and thorough method of utilizing the CAPE Ratio I refer you to Wes Gray and Jack Vogel's more recent work on this particular subject in their paper entitled On The Performance of Cyclically Adjusted Valuation Measures.

 

*This brief summary merely represents some ideas of how to interpret your own results of the stocks that you measure and by no means is meant to be a substitute for a professional analysis of your portfolio or stock purchasing habit