I'm not trying to sell financial advice ...

[F.C.James]

Unlike the Bonus Babies on Wall Street.

But I do have a thought concerning the stock market.

Over the years, when buying a stock, it has always been a good rule of thumb that a price/earnings ratio of over ten was too high. Actually when bargain hunting, it has always been wise to look for a stock with a P/E under 8.

With the market down over 50%, the average P/E of a Dow stock is still over 10.

27 of the DJIA 30 stocks still have a P/E ratio.

The dow stock and it's PE as of 3-20-09.

axp 5.25
bac 11.17
ba 8.88
cat 4.78
cvx 5.54
ko 17.15
dis 8.31
dd 9.39
xom 7.6
ge 5.56
hpq 9.03
hd 16.54
ibm 10.37
intc 15.91
jpm 16.92
jnj 11.31
kft 11.53
mcd 14.13
mmm 9.39
mrk 7.34
msft 9.14
pfe 11.35
pg 10.51
t 11.72
utx 8.27
vz 13.13
wmt 14.62

Average P/E = 10.55

I suppose this shows just how over valued the stock market has been for the past 20 years. Even with a 50% sell-off, it's STILL over priced.

[Flying Dream Blues]

1. Interesting post and welcome to DU! nt

[terisan]

2. thank you.

[Statistical]

3. A fixed rule on P/E is useless

It would be like saying never buy a house more than $200,000 (or $50,000 per bedroom).

$200,000 might be a good deal in one area and horrible deal somewhere else.

P/E by itself tells you nothing.
More useful is PEG P/E / growth rate but event this is just one stat. You need to look at companies' peer, profit margins, debt to equity ratio, competitive advantages, legacy costs, etc.

A company with P/E of 20 and 3yr forward looking growth rate of 27% is a more prudent investment than say a company w/ P/E of 10 and forward growth rate of 3%.

Of course that assumes all things are equal.

There is no magic number for stock market but PEG is far more useful than P/E. Near the end of their usefulness many telegraph companies, typewriter companies, ocean liner companies, railroad companies, and other companies beginning the slow & long decline had very very very low P/E sometimes <3. They were not good growth companies.

The real danger is buying a company with HIGH P/E just as the company begins to slow down. As company slows down the multiple will decline so even if earnings grow the stock will decline. A company that WAS growing at 30% could justify a P/E of 30-40 but now is growing at 10% justifies a much much lower P/E. Get caught in a company with declining multiple and you will see big losses despite the company showing good #s qtr after qtr.