Financial Engineering Con in Stock P/E Ratio
At a Christmas party a friend of mine told me that I was crazy to be "Out of the System" at this point in time. His reasoning was what he was told in college - that the Price/Earnings Ratio is the most important thing you can look at when assessing whether the stock market is over valued or undervalued and at a P/E under 20 the markets are undervalued based on the past 10 years. True - he's not the brightest bulb in the night sky but I have often heard people say the same thing.
It got me thinking. What are all these ratios, averages and adjustments that people talk about as if it is reliable data to make decisions upon. The P/E Ratio, the DOW Industrial Average, Seasonally Adjusted Data and One Time Charges that seems to happen over and over again for some companies.
I lump it all into the category of "Financial Engineering." Engineering your earnings such that it conforms with what an investor wants to hear. Things like "Off Balance Sheet Financing" and "VAR Derivative Valuation" all calculated to show the least amount of risk and keep as much of it off the balance sheet in order to Engineer the books. Although some may call it FRAUD, Financial Engineering is now taught in some of the highest ranked business schools in America. In this twisted world we live in where black is white and and wrong is right - this is all acceptable practice.
It even made Wikipedia...so how could it be a fraudulent practice? Just read how sophisticated committing legal fraud has become...
Financial Engineering
https://en.wikipedia.org/wiki/Financial_engineering
Financial engineering is a multidisciplinary field involving financial theory, the methods of engineering, the tools of mathematics and the practice of programming. It has also been defined as the application of technical methods, especially from mathematical finance and computational finance, in the practice of finance. Despite its name, financial engineering does not belong to any of the fields in traditional engineering. In the United States, the Accreditation Board for Engineering and Technology (ABET) does not accredit financial engineering degrees. In the United States, financial engineering programs are accredited by the International Association of Financial Engineers.
END
Hmm. So if you use methods taught in school using computers and algorithms you can twist, change and totally distort your earnings because WE ARE SMARTER ABOUT ACCOUNTING NOW THEN WE WERE BEFORE.
For the rest of us Schmos in America, laws are written to be followed - for Wall Street and Corporate America, laws are written as a guidepost of what you need to work around.
Back to the P/E Ratio argument for the stock market being undervalued or overvalued. Prior to the 1980's and the introduction of computers, when there was much less "Financial Engineering," the Historical P/E Ratio ranged from 10-15 never going below 5 and rarely going above 20. These days 20 is seen as an average in a fairly priced market.
Many claim it's the natural progression of our markets but very few point out that the bottom denominator, the EARNINGS part of the equation, is a totally and completely "Engineered" number. It is not an apples-to-apples comparison. It is fictitious and, in my opinion, a total and complete lie. Using the old ways, the outdated accounting of our past, the current P/E Ratio is more like 40-50 and in my opinion, after the next crash (if the markets even exist anymore) all these Financially Engineered numbers will be thrown out and the Old Way of Accounting will be demanded.
So where does that leave my friend and his position that the Stock Market is fairly valued at a 20 P/E Ratio? Try dividing the current market P/E valuations by FOUR leaving us with a DOW at 4,012 and the S&P at 471.
So much for the P/E Ratio argument. Poor man's gonna lose his shirt.
May the Road you choose be the Right Road.
Bix Weir
PS - This Friday Road Trip has been posted for Private Road Members here:
//www.roadtoroota.com/members/Sneak_Peak_Chapter_8_Justice_for_Silver_Investors_4.cfm
