One of the prime screeners value investors use to determine how cheap a fund is relative to its value is price—or in financial vernacular, it’s price-to-earnings (PE) ratio, but price isn’t always the best indicator of value according to market experts.
“Chief among them are investments described as cheap and recommended to investors for that very reason,” wrote Peter Seilern in the Financial Times. “This sound bite is often viewed as so evident and self-explanatory that it requires no further, detailed exploration or even challenge. Cheap is deemed attractive and lowers investment risk; expensive is viewed with suspicion, is dangerous and heightens the risk of losing money.”
“According to this established view, the main leading indicator of whether a publicly listed investment is cheap or expensive is its price-to-earnings (PE) ratio,” Seilern added. “Bill Gross, the famed US investor, has been at the forefront of international fixed income for more than four decades. He recently warned US stocks could fall up to 10 per cent next year.”
Rather than simply looking at price, Gross contends that investors should also look to dividends to supplement their search for value.
“Investors, he added, should seek cheap stocks with high dividend yields to protect them from losing money,” noted Seilern. “Although cheap stocks are often attractive to US investors, the priority afforded to low PE ratios and high dividend yields is more predominant in the City of London. Their appeal has become more magnetic during times of what people describe as abnormally low interest rates and when the prospects of higher rates seem distant.”