Using Price To Earnings With Value Investing

As I have mentioned, I am creating a new value investing stock portfolio for investing in the long term and I am going to look at Price To Earnings as a ratio for consideration.  This portfolio will be outside of cannabis stocks.  I am an economist and, I am seeing that the US economy is going to contract significantly in the coming months and quarters.  This would be an excellent time to line up new stocks to invest in since the stock market is very likely to move much lower from its recent highs we saw in January.

My most useful strategy to picking out stocks is to look at metrics.  I have about 20 ratios that I will be using to narrow down results.  The ratios from any one stock will give me values that I can compare with other stocks.

What is likely is that I build up a massive spread sheet and narrow these ratios down inside the spreadsheet.

The ratio I want to look at today is driven by EPS, or Earnings Per Share, and then Price-to-Earnings Ratio.

Technology stocks and Price To Earnings Ratio

I have about 620 different stocks that I want to look at.  These stocks are all in the technology retail sector.  Many of the names that you will see in this spread sheet are familiar.  Some, you may never have heard of.

Something to consider is that investing is somewhat of a popularity contest.  If a stock is very popular, the price may be driven upward and the ratios may be skewed because of this.  I am not interested in popular stocks.  I am interesting in valuable stocks; stocks that have value inherent in company that are being unrealized by the market.

Earnings Per Share (EPS)

The very first thing I did was sort out all of the stocks into Earnings Per Share (EPS).

Earnings Per Share tell a potential investor if a stock is earning a positive amount per year, and at what rate.  Earnings per share divides the total amount of earnings a company earns in any given year by total shares outstanding.

If a company is profitable, then their earnings will be positive and you would take the total amount earned and divide that by the shares outstanding.

Of the 620 stocks I have in this sector, ~200 reported negative earnings.  Guess which stocks can be eliminated immediately?

I am not looking for a company that is not profitable.

Positive, increasing earnings

The criteria that I am looking for with my value investing portfolio is that there be increasing revenues, improving margins, and growing profits.  Given this, I am not interested in stocks that have not achieved positive earnings yet; I have enough growth stocks in my cannabis stocks portfolio.

At the same time, however, we are about to see a contraction in the economy.  Therefore, this would make it difficult to find stocks that are continuously increasing with revenues and profits.  After all, revenue is contracting being driving by consumer consumption that is contracting.

Still, what is possible is to look throughout the past few years and see how each stock has performed during a more ‘normal’ economic environment.  Then, with a potential contraction, the respective stock may sell off allowing me to get in at a more optimal price.

Value Investing is for long term

Keep in mind that value investing is geared more toward a long term investing strategy.  I am not concerned so much with the stock price movement once I am in the stock.

Instead, I am more interested in the financials of the company as time moves forward.  If, after I acquire the stocks, revenues increase substantially, margins continually increase, and profits and earnings also increase annually, then the stock will perform well.

But, it is the increasing revenue that I am looking for.  The economy grows at about an average 3.5% annually.  However, profits from some companies outpace that growth rate.  So, I can get ahead of the game from that.

EPS Versus Price

Earnings per share is a metric.  However, by itself, this metric does not give a value investor much information.  Once a value investor owns a stock then, then EPS becomes a metric to follow on a quarterly basis because it shows how much additional earnings an investor earned by owning the stock.  And, since the value investor already owns the stock, their net worth will be growing at a pace that is faster than the economy.

So, at what price should you be looking to buy into a stock?

EPS & Price-To-Earnings Ratio

Once you have the EPS for a stock, or many stocks, then you need to take another step that asks the question: what price did you pay for the EPS?

The math is simple: Take the stock price and you divide that by the EPS.  This gives you the Price-To-Earnings ratio.

The broader market trades at approximately 15x Price-To-Earnings.  This means that the stock price is generally 15x what the EPS is for the S&P 500.

This is a ratio.  And, since a value investor is looking for the best leverage with their investment, you would want the lowest possible number there is.

Price To Earnings Ratio

Price Earnings Ratio Technology Stocks

Here is a breakdown of the Retail Technology Sector stocks that I have.  You will find three pages below.  The first is all of the stocks with their EPS.

Since ~200 stocks were negative with EPS, I removed them from consideration.  The next column shows the stock price, and then the price-to-earnings ratio where I divided price by the respective EPS.

There are some 100 stocks that have a price-to-earnings ratio below the baseline 15 for the stock market.

I will add these stocks to the spreadsheet for consideration.  But, I also have some 19 other metrics to look at.  This is a good first start, and I will continually incorporate adding new stocks, and measuring each company by additional metrics.