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Price-Earnings Ratios On the Rise

January 4, 1986

NEW YORK (AP) _ The stock market’s recent upsurge has lifted a traditional measure of sentiment among investors to its highest level in more than a decade. But it remains far below its peak during the booming market of the 1960s.

The gauge in question is the price-earnings ratio, a time-honored standard used in judging the prevailing degree of enthusiasm for either a single stock or the market as a whole.

Recently, PE ratios, which are figured by dividing a company’s annual earnings per share into its stock price, averaged about 13 to 1. In the mid- to late 1970s, the typical PE multiple often got as low as 8, and rarely exceeded 10.

In the 1960s, by contrast, a reading of about 18 was common, and at one stage it climbed above 20.

The usefulness of PEs in making investment decisions is the subject of unending debate. But almost every student of the markets agrees that they provide a quick, reliable way to measure investors’ optimism or pessimism.

PEs bear watching because corporate earnings and the stock prices that are theoretically based on those earnings often take very divergent paths.

For example, 1985 was generally a sluggish year for profit growth. Yet stock market indicators rolled up gains of 25 to 30 percent, for one of their best showings in the post-World War II era.

The market has doubled since mid-1982 on earnings growth that hasn’t even come close to a similar growth rate.

″We do not need rising corporate profits for the stock market to continue rising,″ contends Charles LaLoggia, a Rochester, N.Y., investment advisor. ″The market is still in the process of adjusting to the new reality of low inflation and falling interest rates.

″Price-earnings ratios are rising because investors are willing to pay more for a stream of earnings when interest rates are falling.

″Any increase in corporate profits in 1986-87 would be a terrific bonus, because it would create a double-barreled effect of rising earnings and rising price-earnings ratios.″

The stock market wound up its 1985 business and embarked on 1986 with an erratic advance in the past week. The Dow Jones average of 30 industrials rose 6.20 to 1,549.20.

The New York Stock Exchange composite index gained .67 to 121.50, and the American Stock Exchange market value index was up 2.95 at 247.73.

Big Board volume averaged 102.15 million shares a day, against 82.45 million the week before.

The past decade has prompted much study of the effects of changing inflation rates on price-earnings ratios. In the inflationary 1970s, some analysts have concluded, investors came to put less value on dollar profits being reported by corporations. In other words, PE ratios fell.

As the inflation rate subsided in the past few years to less than 5 percent, PEs have expanded again.

Most analysts agree that those quantities are just two of the many variables in a complicated equation. Nevertheless, the recent evidence suggests that the behavior of inflation will have much to do with what happens to PEs in 1986.

Some observers believe the depressed state of most commodity prices is a strong sign that inflation will remain low. Others argue that a declining dollar and a stimulative Federal Reserve credit policy pose the threat of an increase in the growth of the cost of living.

If the climate is right, the optimists argue, there is no reason why PEs cannot regain the heights they reached in the 1960s - which would translate into several hundred more points in the Dow Jones industrial average.

″With the current market multiple under 13,″ Keith Pinsoneault, research director at Sutro & Co. in San Francisco, maintained in a recent market commentary, ″it would appear we have quite a bit of room on the upside to go.″

End Adv Weekend Editions Jan 4-5

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