Given current market volatility, we think now is a good time to revisit important value metrics in our four-part series. In the first part of this value series, we will look at the Price-to-Earnings ratios and how you, as an employee or retiree of Small Business Owners can benefit from it. Investors are often trying to find ways to beat the market. If you're one of those investors, you should consider the following proven strategy that has been implemented by some great investors. Value investors figured out how to beat the average annualized returns of the S&P 500 a long time ago, and many have successful track records spanning several decades to prove it. Warren Buffett is certainly the most famous value investor, but there are many others, including Benjamin Graham, David Dodd, Charlie Munger, Christopher Browne and Seth Klarman. This investment style focuses on four metrics that characterize a value investment. These four metrics include the Price-to-Earnings Ratio, the Price-to-Cash Flow Ratio, High Dividend Yield and the Price-to-Book Ratio. These metrics, as you will see, are strong indicators of undervalued security. These undervalued securities consistently outperform the market. We will examine the effect of investing based on certain characteristics, how their investment returns are correlated, and how you, as a fortune 500 employee would be able to take advantage of this information to give you an edge in the market.

The price-to-earnings (P/E) ratio is a remarkably indicative fundamental ratio of future performance, yet it is often ignored or dismissed. As an employee or retiree from a Small Business Owners company, understanding the P/E ratio becomes of great benefit when evaluating potential assets to invest in. Currently the S&P 500 is at a P/E ratio of 40.13, well above its longtime average of 15.91. The P/E ratio is a valuation ratio for a company that measures its current share price relative to its earnings-per-share (EPS). The P/E ratio can be calculated as: Market Value-per-Share/Earnings-per-Share. The P/E ratio indicates the price an investor is willing to pay for each dollar of net earnings for the company. For instance, if a company had a share price of $20 and its EPS is $2 then the P/E ratio is 10. A stock that trades at a low P/E is generally considered “cheap”, while a stock with a high P/E indicates a more expensive stock as investors might expect more growth. With a volatile market, it is understandable to wonder how the market is going to perform moving forward. When comparing historical P/E ratios with short-term future performance it is still apparent that “cheaper” stocks outperform (shown to the right). In addition to higher average performance, it was found that (when looking out one year) the market was higher 77% of the time if the P/E ratio was below 13.2 as compared to 58% of the time when the P/E ratio was over 19.1. As an employee in a Small Business Owners company, it becomes imperative to understand these metrics and utilize them to your advantage in order to make the most of your unallocated assets.

As an employee or retiree of Small Business Owners, you understand the value of data-driven research. In a study by Quantitative Alpha, they analyzed the performance of the 1000 largest global companies (by market cap) by sorting them into quintiles based on price-to-earnings ratios. Stocks with negative earnings were excluded. They examined the returns of the five equal portfolios consisting of 200 stocks each over a twenty-one-year period, from December 31, 1995, to December 31, 2016, with the portfolios rebalanced quarterly. Their results are shown in the charts below and on the next page.

In their study, they found that the quintile of lowest P/E stocks significantly outperformed the high P/E quintile. As a fortune 500 employee or retiree, this information is very valuable as it may help you increase your gains. The analysis conducted demonstrated that the portfolio containing the lowest P/E stock returned 11.61% annualized compared to 4.83% for the highest P/E portfolio and 7.55% for the used universe of stocks. The graph below shows how the cumulative returns compare (it’s not even close). In a study over a longer time period, screening for low P/E stocks has been shown to have less downside risk than high P/E stocks. By understanding this relationship, a Small Business Owners employee or retiree becomes unlikely to partake in risky market moves, and instead synthesizes a portfolio with lessened volatility and increased returns. In a backtest from 1979 to 2015 (and shown in the chart below), it was found that attractive valuations were followed by lower price declines than high valuations. For every valuation metric under consideration, the chart shows the maximum losses investors could have suffered if they had sold at the worst point in time following a certain valuation level. Under these circumstances, the downside risk increases with rising valuation levels. As a Small Business Owners employee, it is of utmost importance to consider valuation level in order to avoid investing in an asset with further downside which could result in financial loss.

As can be seen in these studies, it is apparent that by simply screening for low P/E ratio stocks with no fundamental analysis, it is possible to outperform not only glamour stocks but the market as well. Not only that, but by choosing stocks with a low P/E ratio, it is possible to reduce downside risk over a long time period. Reinforcing this metric are the value oriented track records of notable names such as Warren Buffet, Bruce Berkowitz and Seth Klarman who all use the P/E ratio as a key indicator for their investment universe. Over the long run, the low P/E ratio acts as a strong indicator of a value investment. With “cheap” stocks tending to outperform and have less downside than more expensive stocks, The P/E ratio becomes an essential tool for planning Small Business Owners employees' and retirees' retirements.

The Retirement Group is a nation-wide group of financial advisors who work together as a team to help those employed and retiring from Small Business Owners companies.

We focus entirely on retirement planning and the design of retirement portfolios for transitioning corporate employees that are part of the Small Business Owners demographic. Each representative of the group has been hand selected by The Retirement Group in select cities of the United States. Each advisor was selected based on their pension expertise, experience in financial planning, and portfolio construction knowledge that are tailored to catering to the needs of employees in Small Business Owners companies..

TRG takes a teamwork approach in providing the best possible solutions for our clients’ concerns. The Team has a conservative investment philosophy and diversifies client portfolios with laddered bonds, CDs, mutual funds, ETFs, Annuities, Stocks and other investments to help achieve their goals. The team addresses Retirement, Pension, Tax, Asset Allocation, Estate, and Elder Care issues. This document utilizes various research tools and techniques. A variety of assumptions and judgmental elements are inevitably inherent in any attempt to estimate future results and, consequently, such results should be viewed as tentative estimations. Changes in the law, investment climate, interest rates, and personal circumstances will have profound effects on both the accuracy of our estimations and the suitability of our recommendations. The need for ongoing sensitivity to change and for constant re-examination and alteration of the plan is thus apparent, which is why TRG is preferred amongst those retiring from Small Business Owners companies as we are constantly verifying the accuracy of our estimations and conducting market analyses to keep our clients ahead of the competition.

Therefore, we encourage employees of Small Business Owners companies to have your plan updated a few months before your potential retirement date as well as an annual review. It should be emphasized that neither The Retirement Group, LLC nor any of its employees can engage in the practice of law or accounting and that nothing in this document should be taken as an effort to do so. We look forward to working with tax and/or legal professionals you may select to discuss the relevant ramifications of our recommendations.

Throughout your retirement years we will continue to update you on issues affecting your retirement through our complimentary and proprietary newsletters, workshops and regular updates. You may always reach us at (800) 900-5867.

1. What to do with an Early Retirement Ebook

2. Social Security Ebook

3. Lump Sum vs. Annuity Ebook

4. 401(k) Rollover Strategies Ebook

5. Closing the Retirement Gap Ebook

6. Tweedy Browne Company LLC. “What Has Worked in Investing: Studies of Investment Approaches and Characteristics Associated with Exceptional Returns”