P/E Valuation as Predictor of ETF Performance (ETFs: IWM, MDY, DIA, XLE, SPY, IYG, XLB, XLI, IGE)

Roger Nusbaum submits: Here's an article from MarketWatch about a research shop named Buyside Research that tries to do bottom-up analysis on ETFs.

According to the article, Buyside Research scores ETFs for valuations based on P/E ratios and high earnings growth.

They currently believe that IWM, MDY and DIA are not compelling values. They do give high scores (which is a good thing) to XLE, SPY, IYG, XLB, XLI and IGE.

I’m not sure this is the best way to assess ETFs. ETFs, for the most part, track indices. P/E ratios have a poor record for predicting moves in the broad stock market. The Russell 2000 and the S+P 500 are both pretty broad measures of the market. P/E ratios were high for years as the bubble inflated. There are also long periods in market history that have had low P/E ratios but where stocks did not do well.

P/E ratios can be useful for comparing one stock with a similar stock as one of several measures of valuation, but I would not rely on this method to guess where the market is going. If you have been reading this blog for a while you may have noticed that I have never talked about P/E ratios as a determinant for the entire market.

Another thing that I don't understand is how SPY scores well in their method, but DIA does not. The extent to which they are correlated ebbs and flows, but as the chart shows the two trade similarly:

I would not doubt that I would lose a debate on the matter but I just don’t think this method can work well in the manner it is being applied.

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