In the previous post, we tried to create a portfolio using the Market Price / Book Value ratio. We looked at the results of an imaginary ₺100,000 investment in a period of one year and five years.
This post is going to be about the P / E ratio. This ratio, which is defined as the price-earnings ratio, is the ratio of the price per share of a company to the profit per share.
XYZ has one million shares -one million lots- in circulation. XYZ made a million dollars profit this year. So what is the earnings per share? It is a dollar. Let’s say one lot of XYZ is trading at $ 30 on the stock market. This stock you bought for $ 30 will bring you one dollar of profit according to the profit announced in a one-year period. Do you think this is a sensible investment? Of course not. This means that I will invest 30 dollars and only make a dollar profit. In that case, it will take 30 years for me to pay off my investment. That’s the rule. But of course, even a share with a P / E ratio of 180 can make a premium, increase or decrease. Why is that? Because the profit to be announced in the next balance sheet will increase, as a result of their follow-up, investors notice this in advance and start investing. So could there be another reason? Yes, it could be just a speculative increase. Think about it, you will make an investment. An airline stock catches your eye. This is when the Covid-19 cases are on the rise. The shares are on the rise; P / E ratios are very high and P / B ratios are also high; But there can be no sectoral expectations, you are in the middle of the Covid-19 pandemic. It is not possible for an airline company to make enough profit to raise its shares in this environment. Here you need to understand that the rise of this stock is speculative and perhaps even manipulative. There will be no stability in speculative ups. Risk is high due to lack of stability. You can buy the stock at a high value and watch its value decrease. So, we need to understand whether the increase or decrease of a share is speculative.
Let’s create our portfolio now. I will create a portfolio from the end of 2014 and the beginning of 2015. We will be watching a one-year performance. Just like I did at the P / B ratio, this time I will select four companies. The companies I choose will be those with the lowest P / E ratio. Remember, a low P / E ratio means the stock is cheap. Well, is there a rule that if it is less than 1 as in the P / B ratio, it is cheap, and if it is higher than 1, it is expensive? Nope. The basic rule here is that the P / E ratio can be at the smallest values higher than 0. Where the price of all is 190, 150 is cheap. If the price of all is 5, 8 is expensive. So, when looking at the P / E value, we will look at “others” and say something relatively. Here, taking “others” as other companies in the same industry will give a better, more reliable result.
For the above timeframe, the four companies I will add to my portfolio are: TUPRS, YKBNK, THYAO and ALBRK. (These are stock exchanges in Turkey.)
Warning: This is not investment advice. The chart below is from 2015 and is without details. It was created to give an idea. The following companies are in Turkey.
Blue Line: My Portfolio
Orange Line: BIST100 (the average earnings of the 100 largest companies on the stock market in Turkey)
As you can see, the portfolio I created using ONLY the P / E ratio performed very superior to BIST. As my portfolio started the year with an index of around 3800; It ended the year with an index of around 6500. BIST started around 350 and finished around 420. While my portfolio made my ₺100 roughly ₺170; BIST’s overall index made ₺100 to ₺120. The inflation value for 2015 was 8.81%. Therefore, I have achieved a very superior performance as a result of a year investment with the P / E ratio. I was able to make a profit well above the inflation rate. Without tiring myself, without getting lost in many fundamental and technical analysis terms, without watching the indexes on the screen for hours; I could only create a portfolio that I controlled from balance sheet to balance sheet, month to month. This is actually the nature of the investment. Investing is not about trading constantly, but about making a satisfactory profit at the end of a certain period by investing money in the right places.
I will check my portfolio again at the beginning of 2016. I will examine the P / E and P / B ratios of the shares of four companies in my portfolio. I will examine other companies in the same sector, if the P / E or P / B ratio has increased too much and there are no new investments that may come from the company whose shares I bought, I will remove this company from my portfolio. I will look at the stocks of other companies. Since I know that this process will take some time, if I start all this work in early December 2015, I can start 2016 with solid research and knowing what changes to make in my portfolio. In this way, I can maintain around 70% profit per year with simple techniques. If I keep this investment for five years and keep my profit rate of around 70% by making the right moves, my ₺100,000 could reach around ₺1,500,000. Moreover, 70% rate is not bad annually for someone who is interested in the stock market, but it is not exactly what is desired. We expect 100% annual return in the stock exchange. But for this, we know dozens of techniques and follow closely. Therefore, it is not bad to have a 70% return without spending that much effort.
You may have noticed something. Return on investment with P / E was better than return on investment with P / B.
You can find all my posts about investments here.