Sunday, April 24, 2011

Stock Market A Voting Machine Even In The Long Run?

I'm reading Gannon's articles on and come across to his article "Book Review: Active Value Investing" and see he quoted Katsenelson saying:
...I wanted to see what would happen to the average P/E of each quintile if I bought each quintile in the beginning of the range-bound market (January 1966) and sold it at the end in December 1982...The highest-P/E quintile exhibited a P/E compression of 50.3 percent. The P/E of the average stock dropped from 29.3 in 1966 to 14.6 in 1982. That portfolio generated a total annual return of 8.6 percent. The lowest-P/E quintile to my surprise had a P/E expansion of 34.8 percent. Yes, you read it right. The P/E of the average stock in my lowest-P/E quintile actually went up from 11.8 to 15.8 throughout the range-bound market. That portfolio produced a nice bull market-like total annual return of 14.16 percent...
Interesting! Interesting! Interesting! The quote of Katsenelson on P/E sounds to me a lot like saying that the stock market is a voting machine even in the long run. To my shallow understanding, voting is about relative value, while weighing is about absolute value. Katsenelson simply said that low P/E relative to the market will expand over years. The number is 16 years here (1966 - 1982), which is fairly long enough to me as in the long run. Although I may not die in 16 years if I'm fairly lucky, considering my age :D. Of course low P/E may also imply low absolute value. But then it means that voting and weighing is not like black and white.

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