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Author: wayjo One star, 50 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 6186  
Subject: Re: Importance of p/e's Date: 1/7/2002 3:28 AM
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I quite agree with the tone of the article and think the market "in general" is closer to over valued rather than under valued.

Firstly, Barcoo I can't be sure but I don't think the market P/E is weighted as I think you are indicating but merely added up and divided by the total market cap or shares issued and so therefore my understanding is that a PE of 20 in 1950 = a PE of 20 in 2002. Happy to hear if anyone knows differently.

The argument in the article totally ignores interest rate movements which has a huge medium to long term effect on the market. Interest rates are generally considered likely to go up rather than down which has a negative effect on market outlook but no-one I follow seems to be forecasting a dramatic rise in either interest rates or inflation so things may not be as dire as the tone they predict. The market is selling at around 17 - 18 times after tax earnings ( a yield of approx 5.5% after tax) v cash rates of 5% so there is no allowance for risk in the current environment.

I have no opinion on whether the market will crash, stagnate or merely rise at the same rate as company earnings but I find it hard to believe that it can continue to outrun company earnings in a rising interest rate environment.

One of the driving forces behind the increase in the market has been the expansion of PE's. I can remember buying NAB and Westpac on a PE of 5 and used to consider banks over valued at 8 times earnings but this is in the days of 12% - 15% interest rates. As of today the banks sit on a PE of 15 so while they have done an excellent job at increasing earnings if prices reverted the PE's of the 80's then it is quite conceivable that prices could halve - but on the other side interest rates would probably need to double as well.

A look at the nifty fifty's of the USA between 1969 - 1974 would dispel anyone's thoughts that blue chips cannot decline from heady PE's. Everyone was buying Avon at 70 times earnings and thinking it would grow forever and yet only 3 companies that I am aware of have grown earnings at over 15% for the past 30 years - McDonalds, GE and Philip Morris. Computershare, Cochlear, CSL investors beware!!

I would be looking to invest in companies that can benefit from higher interest rates such as Insurance companies and companies with low borrowings so earnings are not hurt, as well as companies that can benefit from inflation such as property trusts (although these would be a last resort as their ROA is very low)

Sorry to go on but my 20c worth
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