The simplest way scientifically proven to beat the market.
Price Over Earnings, or P/E or just PE. What is it, and does it work, and why does it work?
For every company, profit has been the goal. But what does that mean? Isn’t profit an evil capitalist lie to exploit the workers and keep them poor?
Quite the opposite.
If you are a farmer, profit = food. For millions of years, humans either “profited” by getting more food than they planted in the ground, or they simply died.
Profit is a necessity for civilization, like food and water. It allows us to have this meeting.
How much you profit vs. how much you have to invest is a good rule of thumb for embarking on an enterprise.
When you divide the investment by how much you profit, that is Price (how much you pay) over Earnings (how much you gain).
Companies tend to grow into relatively stable profits and expenses over time, leading to an expectation that we will gain, in the future, about what we
did in the past.
Thus, companies publish thousands of numbers. And there are thousands of numbers others calculate from them.
But the P/E is the grand-daddy, the others are merely imitators. If you want to make money, and don’t have the time or energy to read all the literature,
just invest in an index fund. They make about 8% a year on average from 1910s until today. That’s better than bonds, or most loans, and far better than inflation.
If you want to beat the market, then invest in low P/E stocks. The average P/E is about 18-25.
If we go back to the farming example, imagine that your farm, after you pay (feed) your people and animals, makes 5 cent profit a year for every $1 dollar invested to buy the farm.
That would be a P/E of 20. .05/1 = 20
Not bad, and that’s after you haven’t starved to death. Great job, you can now do things like paying taxes and having children with that profit.
Now imagine we have 10 farms we can invest in. They have PE ratios of 100,90,80,70,60,50,40,30,20, and 10. One has a PE of 10. That means the farm is making 10% profit each year, or 10 cents on every dollar.
You guessed it, buy the farm with the best profits and you tend to do better than the average farmer!
Similarly, you want the stocks that make the most money for their shareholders, and that means the lowest PE values.
So, that’s what a good investor will look for.
You need to look out for scams, unfortunately, and there’s no common way to do that. Most scams go on for years before they are caught.
So spread out your investments, and look for companies that get steady good incomes.
If you do that, and invest in the top 5th of all stocks in terms of p/e… you will gain about 12% a year in your investing on average, which will double your money 50% faster.
It still helps to be able to read a balance sheet, however most actively managed funds are too consumed by the 10,000 numbers out there to grasp the simplicity of the P/E, and this has been shown.
If you are investing in stocks on your own, there are two rules to keep in mind: Low PE, and buy the stock in the companies you buy things from, since they will do well in the future.