Home Stock Market The Stock Market Myth That Too Many Investors Believe: Why PE Ratios Matter Little For Growth Stocks

The Stock Market Myth That Too Many Investors Believe: Why PE Ratios Matter Little For Growth Stocks

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William O’Neil + Co.’s stock data go back to the 1880s. If you’re like most folks, you might wonder how that is useful at all. The answer comes down to one thought: What works in the stock market and what doesn’t?

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The advantage of data that goes back 100 years or more is that IBD can determine if something has been relevant to successful investing.

Before computerized research, old beliefs on investing didn’t have much behind them. Conclusions were based on hunches.

Sometimes the old, discredited ideas persist among investors, even though research has blown the beliefs apart.

Consider the price-to-earnings ratio, for instance.

“For years, analysts have used P-E ratios as their basic measurement tool in deciding whether a stock is undervalued (has a low P-E) and should be bought, or is overvalued (has a high P-E) and should be sold,” O’Neil wrote in “How to Make Money in Stocks.”

O’Neil continued, “But our ongoing analysis of the most successful stocks from 1880 to the present shows that, contrary to most investors’ beliefs, P-E ratios were not a relevant factor in price movement and have very little to do with whether a stock should be bought or sold.”

Too Pricey To Buy?

Let’s consider several stocks that broke out in the past year or so.

Online retailer Amazon.com (AMZN) cleared a flat base in early January 2018 (1). At the time of the breakout, the stock’s P-E ratio was 194. The P-E ratio of the Dow Jones industrial average was 22.3. Yet, Amazon rose 33% in about 10 weeks.

Internet entertainment services provider Netflix (NFLX) broke out the same week in early January. Netflix’s P-E ratio was 141 the week it broke out. Netflix advanced 63% in about 10 weeks.

Point of sale software provider Square (SQ) had a P-E ratio of 119 when the stock broke out in September 2017. Square advanced 76% in 11 weeks. The Dow’s P-E ratio was 21.2 when Square broke out.

Health savings account provider HealthEquity (HQY) broke out in mid-February of this year. The stock climbed above a 52.53 entry in a handle. HealthEquity gained about 37% in 13 weeks. On the day of the breakout, the P-E ratio was 71. The Dow’s P-E ratio was 22.4.

Ignore The P-E Ratio

Oftentimes an IBD style investor won’t even check the P-E ratio when buying a stock. Ignoring the P-E ratio can benefit investors. Stay focused on earnings, new factors and the market itself, i.e., the seven key items in the CAN SLIM paradigm of growth stock investing.

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