V.9:9 (372-373): Price/Earnings Ratios by Arthur A. Merrill, C.M.T.

V.9:9 (372-373): Price/Earnings Ratios by Arthur A. Merrill, C.M.T.
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Price/Earnings Ratios by Arthur A. Merrill, C.M.T.

Here's a look at an old fundamental analysis favorite and what it can do for the technical analyst.

For many years I have monitored the performance of a group of 30 to 50 stocks that have been exhibiting rapid and consistent growth in earnings per share. They are true growth stocks, with growth rates averaging an increase in earnings per share of more than 20% per year. To qualify for the list, the stock must be listed on the New York Stock Exchange and must have increased its earnings per share in each of the past five years. When earnings falter, the stock is removed from the list. The number in the group varies between 30 and 50 because as poor earnings reports come in on stocks in the group, those stocks are eliminated; when the group has been pared down close to 30, new stocks are introduced into the mix until the group numbers about 50 again.

I've checked the average price/earnings ratio (P/E), a geometric average, of this list for its predictive value and find that in the past five years it has had an excellent record in forecasting market direction for the next 13, 26 and 52 weeks. The method used for testing was described in the May STOCKS & COMMODITIES.

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