Price-earnings ratios are another indicator where the higher numbers supposedly identify growth stocks and the lower numbers belong to value stocks.
But the Barron’s 400—which we have shown in previous Diaries is unmistakably a growth index—turns that concept on its head.
The indicator interpretation is based on the premise that investors will pay up for proven sales and earnings growth. Therefore, according to this theory, prices of growth stocks are more expensive than those of value stocks, and the PE ratios follow suit.
Barron’s 400 stocks, however, are cheaper than those in the 6,000-stock universe from which they are drawn. While the companies represented by these stocks are in solid financial shape and give every indication of being poised for growth, their stock prices haven’t yet been pushed higher than the overall market. The name for this attractive condition is “growth at a reasonable price,” or GARP.
The table below shows the Barron’s 400 PE ratios, both past (trailing) and future (forward) in comparison to those of the broad market. As usual, there are differences among the sectors.
|Median Trailing PE||Median Forward PE|
Note that in every sector but one the median trailing PE ratio for the Barron’s 400 is below that of the universe. The sole exception is in utilities, which is misleading because there is only one utility in the Barron’s 400. MarketGrader’s scoring methodology, which gives a higher grade to a lower PE, is responsible for the index’s GARP attribute.
The pattern does not hold up with forward PEs, however. Only energy has a lower median PE for the Barron’s 400 than for the broad market. One reason for this difference is that securities analysts haven’t estimated earnings for many companies in the broad market, whereas only five of the Barron’s 400 components are missing forecasts.
By the way, those identical forward PE medians for the broad market in consumer discretionary and consumer stapes aren’t typos; they just happened to turn out the same.