Cheap isn't enough

Summary: A low P/E only tells you a stock is cheap against something, not whether that yardstick suits the business or the earnings can be trusted. NJ Mutual Fund’s backtest shows a business-specific Value Score beating a plain low-P/E screen, and quality and volatility filters add a little more return and clearly less risk.

Summary: A low P/E only tells you a stock is cheap against something, not whether that yardstick suits the business or the earnings can be trusted. NJ Mutual Fund’s backtest shows a business-specific Value Score beating a plain low-P/E screen, and quality and volatility filters add a little more return and clearly less risk. Value investing appears simple when you look at a stock screen. You rank companies by a valuation ratio, and those with the lowest multiples rise to the top. That is helpful but only to a certain extent. A low multiple shows a stock price is low relative to something. It doesn’t reveal whether that ‘something’ is the appropriate measure for the business, or whether the figure is reliable. A company whose price is, for example, eight times its earnings may seem cheap. But if the industry’s earnings are peaking, the stock could look a lot less attractive when profits return to normal. That is why evaluating value starts with a more basic question: Cheap compared with what? Choosing the right yardstick Businesses earn