Don't Sell High P/E Stocks Short

Tags: stocks, stock market tips, stocks techniques, stock market guide




When the stock market was at rock bottom in June 1962, a big, heavyset Beverly Hills investor barged into the office of a broker friend of mine and in a loud voice shouted Xerox was drastically overpriced because it was selling for 50 times earnings. He sold 2000 shares short at $88.

After he sold short this "obviously overpriced stock," it immediately started advancing and ultimately reached a price equal to $1300 before adjusting for stock splits. So much for amateur opinions about P/E ratios being too high. Investors' personal opinions are generally wrong;markets seldom are.

Some institutional research firms in recent years published services and analyses based on the principle of relative P/E ratios for companies, compared to individual company earnings growth rates. Our detailed research over many cycles has shown these types of studies to be misleading and of little practical value.

The conclusion we have reached from years of in-depth research into winning corporations is that the percentage increase and acceleration in earnings per share is more important than the level of the stock's P/E ratio. At any rate, it may be easier to spot emerging new trends than to accurately assess correct valuation levels.

In summary: Concentrate on stocks with a proven record of significant annual earnings growth in the last five years. Don't accept excuses; insist the annual earnings increases plus strong recent quarterly earnings improvements be there.