The Usual Dilemma: To Buy or Sell?

Chart of the Week for February 9-15, 2001

“Is now a good time to buy stocks?” Many investors have been asking this question recently amid indications that the economy is slowing.

Traditionally, when consumers perceive an economic slowdown, they slow personal expenditures. Sales—hence corporate earnings—decrease, causing these companies’ stock prices to fall along with their profits. The result is a low price-to-earnings (P/E) ratio.

Using the S&P 500 as the proxy, P/E started to rise impressively in the early ’80s from a low of 7x to reach a peak of 34.7x in June, 1999. As of January 31, 2001, the index’s P/E declined to 27.9x, more than a 7-point fall. However, this ratio is still high and is more than 4 points above the average— 23.5x — for the time period considered in the chart. Traditionally, growth-oriented sectors such as technology tend to have excessively high P/Es that do not necessarily reflect the true value of the stocks. Value-oriented companies, on the other hand, tend to exhibit low P/Es. As value stocks are on the rise, investors who consider P/Es a main factor in their investment decisions may find a lot of attractive opportunities in the markets.

Though short-term buying and selling decisions can have an immediate impact on portfolio, investors are advised to focus on the long run.

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