Valuation #2: what earning?

Yes, I am feeling nervous about the "stent" insertion (into my kidney) procedure next week. All things being equal, it is generally not a good idea to either put something in or take something out of your body cavity. Any surgery comes with risk. Otherwise, the hospital would not ask you to sign a waiver form; just in case.

I even chose not to circumcise my son Ace. I am a simple man. I like to keep all things as we were, if possible. I just see no reason to cut out a fold of skin on your baby's penis. By the way, it hurts. Even babies get erections, I've seen it. Anyway, I'm a little bit nervous.

Assuming you have read my "Valuation #1" piece, let me continue the thoughts. We now understand that PE & PS ratios are quick and easy methods of relative valuation. Additionally, you should now know that PE (Price Earnings) ratio of 20X, implies an internal rate of return of 5% (assuming that the earnings do not grow). As such, if you pay 10X PE, you're getting 10% and so on.

So, do stocks with low PE ratio, offer better value than high ones?
Generally yes, but it is not that simple. Otherwise we will all be rich by now investing in low PE stocks. The most important factor in looking at the PE number is knowing "which" earnings? To recap, you get the PE number by dividing: the share price (P) by the earnings per share (E). But what earnings are you talking about? If you pick up the newpaper such as the Wall Street Journal, the PE numbers are based on last 4 quarters. (Last 12 months of earnings? Who cares?).

Here's a simple question: If you were buying an investment property (2 bedroom apartment) that the tennant used to pay $1,000/mo. in rent (your earnings from this investment) to the owner (you) but the tennant will be moving out in 2 months after your purchase and worst of it all, you have no idea how long it will take to gain a new tennant (no imcome). Would you still pay the same price as if $1,000/mo, income is guaranteed? Of course not!

As far as I am concerned, the only logical earnings number is the future earnings. Next 4 quarter is sufficient but the longer we can look into the future earnings numbers, the better. Many times, you can get these estimates from Wall Street analysts or directly from the companies themselves. Knowing how "legit" these estimate number is, is more art than science. This is where your gut comes into play. If you've been following the company for a while, listening to the conference calls by the CEO, eye witnessing the new events unfold, you start to get the feel for the numbers.

This is why stocks fall like a rock when they miss the numbers.
Once I loose confidence in the management, sayonara! (translation: get lost).
There are plenty fishes in the sea. I do not need a lier, imcompetant manager or simply a looser.

Here's another rule in life: Loosers tend to be loosers, winners somehow keeps winning, complainers always find things to complain, and chances are, the majority of poor will be poor and the rich will get richer.

Let's work hard to be rich and happy OK?
It is soooo much better than poor and happy.