There is plenty of evidence and documentation indicating the significance of paying attention to the price action of glamour stocks and stocks that allow the fat cats through the doggie door. During this past week I came across a couple of concepts about assessing market health through high P/E stocks and decided to incorporate this with my analysis of stocks that allow size to move in and out. I believe that coupling these approaches of market analysis can lead to better understanding of what is happening now via two categories of stocks informing of the general risk appetite, as well as the general sentiment of those who move the needle.
Investors Business Daily focuses upon growth and their research indicates that growth stocks will typically correct 2x-3x that of the general market averages. Additionally they have noted that some of the more notable stocks of the past will have a high P/E ratio in part due to the premium being paid based upon the perception of future earnings. They document that, “These findings strongly suggest that if you weren’t willing to buy growth stocks at 25 to 50 times earnings, or even much more, you automatically eliminated most of the best investments available… In a roaring bull market, don’t overlook a stock just because its P/E seems too high.” HTMMIS 5th pg. 200-201. When the future prospects of growth stocks become discounted, these beauty queens can rapidly turn into ugly ducklings, drawing down one’s capital like quick sand. As a result, a significant draw down may result in the death of a trading account, or a prolonged struggle just to get one’s feet back on the ground and break even.
I tend to take a logical approach to my market studies in theory, and unfortunately an (at times) irrational one in practice. Taking this information from IBD and developing a process of analysis from it the key points here are that the best winners of the past will be ranked above 25 to 50 P/E, and during a bull market there mere perception of future potential trumps current rational assessment of fair price and value. In a weakening market, watching for signs that these runway models are tripping off the catwalk en masse can be valuable information and there are two publicly available tools that can assist us in this. Using FinViz I created a simple scan: P/E High(>50), Price Over $10, and Average Volume Over 100K, then ordered by Performance Month for the following RESULTS
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| High P/E Screen |
Recently I found a new chart software TradingView which allows one to create a basket of stocks as an index. Using this scan I charted the first 10 from this list:
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| High P/E |
The second FinViz scan I created was for Big Cap stocks, the type that allow size in and out. RESULTS
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| Big Cap Screen |
Using the top ten from this list produces the following chart
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| Big Cap |
Now that there is a simple process for breaking down high P/E and large cap stocks and creating a basket index of their performance over a Monthly/Quarterly time frame, the next step is to decide upon which questions are pertinent in order to make the data meaningful. As a swing trader questions that I’m most likely to find of interest are: How are the high flying, darling, IBD type, growth stocks performing? Are the general market indexes showing strength while these stocks are correcting several multiples? Are stocks with high P/E showing positive monthly and quarterly performance or waning on one of these time frames? What types of stocks show up on a monthly/quarterly time frame that allow size in and out? Are these stocks up on a shorter time frame more aggressive or defensive oriented? What about the inverse, are those down more aggressive? There is plenty of wiggle room to frame the market within our personal time frame and trading mentality, but first one must determine if this information is useful to begin with and applicable, otherwise it's just more disinformation in an already cluttered world of trading noise.
