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Bargain hunting.

Good points Harmy. I have a keen interest in this as well.

G'day all. Sorry I haven't been posting much lately, but I have been reading all the posts. Inxcidentally, I do hope we haven't lost jono.

I haven't been wasting my time lately, even though I wasn't here. I've been revisiting an old tactic that worked very well in '98 and '99. The method simply involves imagining what the price would be if its P/E were 15.

I think it was Ben Graham who pointed out that the market average Price to Earnings ratio is about 15 in boom times, and about 10 in recessions. I think Philip Fisher developed the idea a fair bit further and arrived at the Dogs of the Dow'. That has since been discredited, and I think he took the approach too far.

Here's a simpler mechanical method that will deliver pretty good returns consistently, as far as I am aware, although I have not back tested it thoroughly.

The theory behind the method is based on the following assumptions:
Prices will inevitably follow earnings
Regardless of how fast a company is growing now, at some point in the future, its growth will taper off to match the growth of the economy or sector it belongs to.
At that future time, its Price to Earnings ratio will match the market average – 15 in good economic times.
In bad economic times, an investor is probably better off not in the market, so we only concern ourselves with the prospects of good economic times.

The method is simple
Limit the lis to large companies, say the ASX top 300, or those with Market Caps greater than $300million.
Eliminate Property and other stocks that pay out all of their dividends, and do not reinvest earnings in business growth.
Eliminate Resource stocks, since their value is determined by the value of the resource, not the acumen of the business.
Eliminate stocks that do not provide future earnings estimates for the next two years. (This is not so important, and will work quite well even using just the past year's earnings.) Often, though, the market looks ahead, and it is worth considering the future years' earnings.
This will leave you a list of t 130 stocks. (Ninemsn's Finder function is brilliant for this).
Multiply the current Earnings Per Share, the one year forecast EPS and the two year forecast EPS by 15 for each stock. Aren't spreadsheets wonderful?
Divide each of those three figures by the current price to give a projected gain.
For the one year figure, take the square root, to give an annualised return.
For the two year figure, take the cubed root.
For each company, pick the highest of those projected annual returns.
Rank them from highest to lowest.
Pick the top twenty.

You can expect up to five duds in this list. The returns on the others are very good.

More on this subject later,


Chris
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