Letters of the Week

Small cap shortage. Which bank story to believe? The value of P/E ratios.

Small cap shortage
Thank you, Rachel, for the excellent analysis on the bunch of small caps. Unfortunately, the smorgasbord is somewhat bare at this stage. I scanned your lists, using my Technical Analysis stocks screen, but only Clover Corporation made the grade. Since its spectacular 12.5% break-out on March 25, it has maintained the uptrend with higher highs and higher lows (thanks, it seems, to omega-3 popularity). I also scanned ASX indices XJO & XSO and, would you believe, came up with only six stocks: AHE, IAG, DXS, GUD, MLB and OKN. I suppose this illustrates how tough things are in the market place.

– V Massonic

Which bank'¦story?

When the oligopoly that is our Big Four banks gets criticised for raising loan rates and decreasing deposit rates, we get told that they are really squeezed for margin. I think the truth is different and a letter from C Hall (April 4) sums up the very healthy nature of bank dividends. So which bank story would you (bank shareholders) like us to believe? Are the banks ripping off small business and mortgagees or are you really doing it tough?

– B Meaney

P/E ratios

I would be interested in input from a contributor on the value of the price to earnings ratio to illustrate how the market is travelling compared to years past. Some analysts and commentators point to the market’s current P/E ratio compared to its historical ratio as a good guide to assess under- or over-valuation – or, as earnings season approaches, to highlight how the market is priced for positive/negative results. These days however, companies seem to build significant market capitalisation so quickly, on potential rather than actual profit, that it must distort the figures – particularly in the mining and technology sectors. It could be argued that struggling sectors (like retail) provide a balance, but given the generality of the P/E index and the rapid pace of change on markets, has it become just another ratio with very little meaning? And is there a better way to assess the market’s value compared to years past?

– D Palmer

Michael Feller’s response: Historical PE average comparisons are generally a good rule-of-thumb method to assess a market’s value, but as you rightly point out there are times, like now, when this methodology can become problematic. As an alternative to historical PEs, I recently looked at historical profit margins, which are currently being cited as a potential indicator of a bubble in the US equities market (see Pick a pocket of US stocks). Either way, of course, you need to use a combination of these and other ratios (price to sales is also useful, though Roger Montgomery may have a different view – see Value.able: BHP's fall from grace), to get a reliable picture of value. Indeed, with the huge differences in the fortunes (and profiles) of various industries, you need to look beyond the index and look at sectoral performance –something I also touched on in the same article.

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