by the Price Earnings Ratio Stock Value Tracker Team


ALSO READ: 10 Easy Money Tips for College Students


Check out the PE Tracker here.

The recent volatility in the stock market is a rude reminder that different types of stocks – oil stocks, utilities, foreign ADRs, etc. – can see different kinds of performance.

This is an opportune time to reflect on a very profitable trade I made in 2017, using price earnings ratios as my guide to trade different types of stocks. I looked at two industries. The financial industry which includes banks and the “real economy,” which by my definition includes goods producers like Walmart and excludes finance and tech companies.

*** SPECIAL ALERT -- May 10, 2020 -- Motley Fool Stock Picks On FIRE! ****

The recent Motley Fool stocks picks, even with this COVID crisis, are STILL performing well and beating the SP500! Here are some of their most recent picks and their performance:
  • Shopify (SHOP) – April 2, 2020 pick and it is already up 90%
  • Zoom Video (ZM) – March 19, 2020 pick and it is already up 16%
  • DexCom (DXCM) picked Feb 20, 2020 right before the market crashed and it is still up 17%
  • Tesla (TSLA) picked January 2, 2020 before the crash and it is up 77% compared to the SP500 -12% so it is ahead of the market by 89%
  • HubSpot (HUBS) picked December 5, 2019 and it is up 4%
  • Netflix (NFLX) picked November 21, 2019 and it is up 37%
  • Trade Desk (TTD) picked November 11, 2019 and up 50%
  • Zoom Video originally picked Oct 3 and it is up 87%
  • SolarEdge (SEDG) picked September 19, 2019 and it is up 20%
  • Zoom was also picked October 3, 2019 and it is up 95% since then.
The average stock they've recommended is up a life-changing 346% - more than 4X the return of the S&P 500 ! Now, no one can guarantee that every pick in Stock Advisor will have the same mind-blowing returns as Netflix and Disney. But you sure don't want to risk missing out.

Normally the Fool service is priced at $199 per year but they are currently offering it for just $99/year if you click this link

Hurry! Order now so you will get their next stock pick! Here is the expected schedule of release dates for their stock picks...:

  • June 4 - Tom's New Recommendation
  • June 11 - Tom's New Best Buys Now
  • June 18 - David's New Recommendation
  • June 25 - David New Best Buys Now

CLICK HERE to get The Motley Fool's Stock Picks for just $99 per Year! 

Hypothesis

My hypothesis was that the P/E ratio of stocks in the financial industry would converge to the real economy P/E ratio after noticing a big disparity between these two numbers. Let’s say the P/Es were 10 and 20, respectively. Academic theory and popular trading strategies like “Dogs of the Dow” hold that P/E ratios of different stocks should converge to the same number (revert to the mean) in the long run. (If you want recent evidence from an academic, a paper by Kevin Klassen here confirmed mean reversion in P/E ratios from 2008-2017.) I expected the sentiment around the new presidential administration and its actions to act as a catalyst for my trade in the short-term.

Execution

I bought a trading instrument to reflect a basket of financial stocks in March 2017. You can take the financial index from Vanguard (Ticker: VFH) as a close substitute. I set a P/E ratio target for the financial index. This involved a little bit of magic and a little bit of judgement based on facts I won’t get into here. The P/E target was not quite as high as the level of the P/E of the real economy stocks, but higher than what I believed to be a depressed current P/E ratio for financial stocks. Let’s say the target was 15.

I closed the trade almost a year later by selling the financial index in Feb 2018 once the P/E ratio hit my target.

How did my purchase fare?

The P/E ratio of financial stocks indeed went higher and converged closer to the level of real economy stocks! More concretely, financials were up 18% in price vs. the S&P 500 increase of 16% over the mentioned time frame. This is not counting dividends which are higher for financials.

What’s more, if you exclude financial and tech companies from the S&P 500 to include only “real economy” stocks, the outperformance of financials was even more profound. My hypothesis proved correct.

Conclusion

Here is another way to look at this concept. Compare two stocks, one from the financial world and one from the real economy world. If you had bought both in 2015, your Bank of America stock (PE Ratio: 7.2x) would have over the course of this period typically outperformed Johnson & Johnson (PE Ratio: 23x). Notice the 2016 presidential election result was a huge catalyst that sent Bank of America’s stock price sharply up. Now if you had chosen Goldman Sachs, which has been experiencing company specific issues, the story would be much different. That is why I recommend looking at baskets or indexes of stocks to diversify away company-specific issues. And, of course, the recent market crash related to the coronavirus definitely adds a large element of uncertainty om the near term.

I believe that with an understanding of P/E ratios and good timing, you can continue to make money by betting on P/E ratio convergence. I believe it so much that I created an app with my team to serve as a handy dashboard for traders and investors. With my Price Earnings Stock Value Tracker app, you can see the P/E ratios of 18 critical US companies plus the median of three custom indexes, which include financial and real economy stocks.

Check out the PE Tracker here


INVESTING TIP #27-- HOW TO GET FREE STOCK!

Get Up To $1,000 in Free Stock with Robinhood--the Commission-Free Brokerage!

Open a new account and receive one free stock valued at up to $500! Then, once your account is open, get more free stocks (value from $5 to $500) for each friend, family, person you refer! USE THIS LINK to get started with Robinhood!

LEAVE A REPLY