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bridging the gap


Guest notorious546
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Guest notorious546

hi all,

 

i recently listened to a podcast with michael maubossin and patrick o'shaunessy. at one point they were discussing valuation and patrick brought up the point that if you rank stocks by P/E, lets say quartile the lower P/E multiples tend to outperform. This point is well documented in many pieces like tweedy browne's what works in investing. often on the forum there is discussion of people saying X company has an P/E of 40x-50x therefore it is a sell and the same commentary on Y company has a P/E of 5-10x therefore is a buy.

 

the second group of people say that multiples having nothing to do with intrinsic value and that just we should just arrive at a firm view on instrinsic value and buy at a discount for it?

 

In sum two options i guess here to choose, which one and why?

1) multiples (historic data)

2) discount to IV (unclear data)

 

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Personally, I think it is just a quirk that low PE stocks tend to outperform. There are many reasons why a stock has a low PE:

- High debt load

- Melting Ice Cube

- Cyclical at cyclical peaks

- Low quality earnings

- High capital intensity

- Low growth

- Low ROE

- Volatile earnings

- Frauds

 

On the other hand, low PE stocks also include out-of-favor, low-expectations, reversion-to-the-mean, margin-of-safety "cigar butts". High PE stocks include over-valued, fads, promotional IPOs, momentum, go-go stocks etc. But High PE stocks also include cyclical companies at cyclical bottoms, cash-rich companies, wide-moats, high ROIC, J-Curves, consumer staples etc.

 

In the end, these things have tended to balance out in a way that favours low PE stocks, quantitatively. But it is absolutely true that SBUX at 15x is a better investment than OUTR at 10x.

 

 

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