As prudent investors, we all know that nothing is risk-free, the markets do not go up forever, nor down forever, corrections will happen, and the historical trend on the markets since the beginning of recorded history has been up, not down.
We also know that markets can crash or suffer a steep correction, only to eventually bounce back to previous levels and move higher. One of the more often looked at financial metrics is the forward P/E ratio of any particular company.
Looking At A Stock Using The Forward Price-To-Earnings Ratio
To understand the value of the forward P/E, let's take a look at what Investopedia has to say:
A measure of the price-to-earnings ratio (P/E) using forecasted earnings for the P/E calculation. While the earnings used are just an estimate and are not as reliable as current earnings data, there is still benefit in estimated P/E analysis. The forecasted earnings used in the formula can either be for the next 12 months or for the next full-year fiscal period.
Also referred to as "estimated price to earnings".
Since there are no perfect ways to estimate what the future holds, the current P/E might be somewhat better in looking at a price today. That being said, the markets are all about tomorrow, not today and yesterday, so I believe that a forward P/E ratio, which is calculated by the earnings forecast of each company itself, is a far better reflection of what to expect over the longer term.
The estimated P/E of a company is often used to compare current earnings to estimated future earnings. If earnings are expected to grow in the future, the estimated P/E will be lower than the current P/E. This measure is also used to compare one company to another with a forward-looking focus.
I believe that a well-allocated and diversified portfolio can be compared to the overall S&P 500 forward ratio for a glimpse at what the future MIGHT hold for long-term investors.
Where Is The S&P 500 Right Now, Pertaining To Forward P/E Ratios?
Let me toss up a current chart of the S&P 500 P/E ratio as it stands today. (From Robert Schiller)
Some raw data:
This chart is as of yesterday, 6/9/2014. The current P/E ratio of the entire S&P 500 stands at 19.47. To some investors, it signals that a market correction is ready to happen. While there is some truth to that, since the last several times the ratio was that high, the markets dropped. A few times, precipitously.
Of course, since the historical trend of the markets is up, the averages (and the majority of each individual share price) have recovered.
Take a look at this chart to see what I am saying:
The index has always recovered and reached new highs. I believe the trend will continue for as long as most of you reading this article are alive. Obviously, the longer your time horizon, the easier it will be to recover from the major drops.
Those who are either close to retirement or already retired could be faced with a prolonged recession, which will be hard, or impossible to recover from. However, that is ONLY about the total value of a portfolio, ergo; the share price.
By sticking with a dividend investment approach, the goal for investors is to receive income. The amount of income is derived from the number of shares held in any particular stock (not the share price), within a portfolio. By sticking with dividend-winning stocks, the actual share price fluctuations of any stock is secondary (or lower) to that of the income received from holding those shares.
In the vast majority of cases, dividend champion stocks with long histories of increasing dividends even in bear markets that have steeply corrected is evidenced thoroughly. An example would be a review of this website, which I find quite easy to navigate for dividend growth stocks.
Using My Buy The Dips Portfolio As An Example, Pertaining To The Forward P/E Ratio Of Each Stock
The BTDP consists of the following stocks: AT&T (NYSE:T), Exxon Mobil (NYSE:XOM), Johnson & Johnson (NYSE:JNJ), Coca-Cola (NYSE:KO), Procter & Gamble (NYSE:PG), Altria (NYSE:MO), McDonald's (NYSE:MCD), Chevron (NYSE:CVX), Apple (NASDAQ:AAPL) General Electric (NYSE:GE), Ford (NYSE:F), Microsoft (NASDAQ:MSFT), Wal-Mart (NYSE:WMT) and Pfizer (NYSE:PFE).
Each of the stocks have been or are dividend champions, and in one or two cases, will eventually become one. These are not your typical "trendy" names, nor are they very exciting. However, they pay us to own shares in each company, and will give us an increase each and every year.
Where do these companies stand with each forward P/E ratio?
|52-wk. lo||52-wk. hi||TGT PRICE||Symbol||30-May||Tgt Price||% To Sell||Tgt Price||% To Sell||Fwd P/E|
The chart I have developed shows a price that would be a wonderful target price to buy or add, as well as for those who like to take profits and trim between 25%-50% of their holdings to lock-in profits, hold some dry powder, and/or redeploy into other stocks, to expand the portfolio or increase income.
Not one of these stocks will either stop or cut dividends in any regular correction, in my opinion, and therefore, any correction can virtually be ignored (better yet, an opportunity to add shares!).
Now take a look at the forward P/E ratios to the far right of the chart.
This portfolio is below the current forward S&P 500 level of 16.05. The average from this well-balanced, diversified portfolio is only 14.23!
Does this mean that there will not be a correction? Of course not, but the daily drum beat of the gloom and doom scare tactics would have to overcome this compelling argument that the stocks in THIS portfolio are anything but overvalued. A case could be made by the doom-and-gloomers about comparable P/E levels in stocks of similar companies, but that would mean that the entire forward P/E average of the S&P 500 would be pointless, which of course, it is not.
Those same pundits who proclaim that the sky is falling will have to convince me that my income derived from these stocks will suffer from virtually any type of correction, or even a bear market for that matter. The truth is that with these blue chip, mega cap, dividend winning stocks, my income will go UP, not down.
The Bottom Line
Go ahead and see if you can scare me out of MY shares. I have a wonderful income stream that supports my lifestyle, and I do not have to fear any correction, no matter what.
Look at it this way; let's say you hand over all of your money to an insurance company and receive $10k per month for the rest of your life, guaranteed. That's it, you're done. You have a zero portfolio balance, but you feel "safe".
With a dividend growth investing style, you could have the same income, an increase each and every year to keep up with inflation, and still have access to every single penny within your portfolio, no matter what the valuation might be on any given day.
Read, Decide, Invest... or listen to all the scare tactics and choose fear instead of reality.
"The only thing to fear, is fear itself" Franklin D. Roosevelt, 1933.
Disclaimer: The opinions of the author are not recommendations to either buy or sell any security. Please remember to do your own research prior to making any investment decisions.
Disclosure: The author is long AAPL, CVX, F, GE, JNJ, KO, MCD, PFE, T, XOM. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.