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Issue No. 48 – October 17, 2005 Prescott, Arizona Systems@WiserTrader.com
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1.0 Trading
Since September 12, 2005 we have described the individual effects of year ago stock multiples on current stock prices one year later. Year ago multiples involved price to earnings ratio (PE), price to book ratio (PB), price to sales ratio (PS) and return on equity (ROE). Sales growth was described last week. This week continues with the effect of earnings (EPS) growth.
1.1 EPS Growth
The analysis involved NYSE, NASDAQ and AMEX stocks that had earnings data and were priced above $4. Advanced Depository Receipts, Over the Counter Stocks and Exchange Traded Funds were excluded. Information was available for the group of 2632 stocks shown in Figure 1. The chart on the left shows the entire population. The zoomed in chart on the right shows that for typical EPS growth, one could have obtained a wide range of possible outcomes.
FIGURE 1
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The 2,632 stocks were sorted into seven EPS growth ranges and used to plot 52 week price gain histograms. The data is summarized in Figure 2. Market data for the past year shows that the probability of lowest risk occurred for EPS growth in the range 30 to 50%. EPS growth outside this range was either more difficult to sustain or was not considered to have sufficient value and resulted in a 25% or greater probability of loss.
Probabilities for the lowest price gains of zero to 25% were higher as EPS growth decreased. The probability of price gains of 25% or greater increased with EPS growth.
FIGURE 2
Based on the predictable behavior of price changes with EPS growth, it is likely that a larger percentage of investors use EPS growth as a single indicator of stock behavior compared to others discussed in this series of analysis. There is no way to definitively prove this, however.
The percentages of stocks in Figure 2 can be treated as probabilities of price gains for EPS growth ranges over the past year only. How investors evaluate stocks changes from year to year and accounts for annual changes in the character of the market.
Once again it is good to keep in mind that long term fundamentals are inappropriate for short term trading. From here the study will begin to look at the effects of combinations of multiples, as well as, how they have correlated with price changes over shorter time periods of 3, 6 and 9 months.
2.0 Market Analysis
October is a spooky month for both bulls and bears. More than half the time bear market bottoms have been put in followed by rallies of 5% or more. Other times we have experienced some of the darkest days in market history as in 1929, 1987 and 1989. Last week the market declined due to inflation fears. The CPI was up significantly due to energy but the core CPI was very tame. The market stabilized on Thursday and recovered on Friday. This coming week earnings reports begin in full swing. More choppiness can be expected.
Key industry ETF’s in Table 2A are Biotech and Semiconductors which confirm the NASDAQ. Transportation confirms the Dow Jones Industrial Average according to Dow Theory. Banking and Financials are confirming indicators for the S&P 500. Gold and Real Estate are respective indicators for the inverse health of the currency and consumer spending.
Table 2A
Index Tracking Stocks, Key Industry ETF’s and Sector SPDR’s
|
|
1 month |
1 wk ago |
2 wks ago |
3 wks ago |
4 wks ago |
|
DIA (DOW) |
-3.2% |
-0.1% |
-2.6% |
1.6% |
-2.0% |
|
QQQQ (NASDAQ 100) |
-3.4% |
-0.7% |
-2.8% |
1.8% |
-1.6% |
|
SPY (S&P 500) |
-3.9% |
-0.8% |
-2.8% |
1.3% |
-1.7% |
|
IWM (Russell 2000) |
-6.0% |
-1.9% |
-3.4% |
1.9% |
-2.6% |
|
GLD, GOLD |
2.1% |
-1.2% |
1.4% |
0.9% |
1.0% |
|
RKH, Banking |
-4.2% |
0.4% |
-0.9% |
-0.9% |
-2.8% |
|
IYT, Transportation |
0.3% |
-0.8% |
-1.5% |
3.1% |
-0.5% |
|
SMH, Semiconductors |
-6.6% |
-2.8% |
-4.0% |
2.0% |
-1.9% |
|
BBH, Biotechnology |
-6.1% |
1.2% |
-3.5% |
-0.9% |
-3.0% |
|
IYR, Real Estate |
-7.4% |
-1.3% |
-4.4% |
2.5% |
-4.2% |
|
OIH, Oil |
-6.3% |
-1.8% |
-8.0% |
3.3% |
0.4% |
|
XLE, Energy |
-7.5% |
-2.4% |
-7.7% |
2.1% |
0.5% |
|
XLU, Utilities |
-8.1% |
-4.4% |
-4.0% |
2.8% |
-2.7% |
|
XLB, Materials |
-5.4% |
-1.0% |
-3.3% |
1.6% |
-2.7% |
|
XLI, Industrial |
-1.6% |
-0.6% |
-1.2% |
1.4% |
-1.2% |
|
XLK, Technology |
-4.6% |
-1.0% |
-3.3% |
1.6% |
-2.0% |
|
XLV, Healthcare |
-3.7% |
0.2% |
-1.9% |
-0.4% |
-1.7% |
|
XLF, Financials |
-2.9% |
-0.2% |
-1.3% |
0.6% |
-2.0% |
|
XLP, Consumer Staples |
-1.4% |
-0.4% |
-1.9% |
2.4% |
-1.5% |
|
XLY, Consumer Discretionary |
-5.3% |
-1.0% |
-2.4% |
0.6% |
-2.6% |
