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P/E Increases During Recessions

January 19, 2009 | About:
Saj Karsan

Saj Karsan

21 followers
For most companies, recessions reduce P/E ratios, as investors withdraw money from the market and become stingy with their purchases. We saw this pattern emerge when we looked at the historical P/E of the S&P 500. We also saw examples of companies trading at their historic P/E lows here and here. But strangely, some companies actually see their P/E's increase during economic downturns, and not only those which sell cheap or defensive products. Consider Fedex (FDX).

Fedex is often considered a bellweather for the economy, as when the economy is going well/poorly, Fedex will often see a pickup/dropoff in deliveries. As such, when the economy tanks, one may expect the P/E of FDX to deflate. But here's a look at what happened to FDX's P/E during the last comparable recession:

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So what's going on here? The price component of the P/E value did drop to $40 in 1990 from $64 in 1987. But the earnings dropped even more. When this occurs, the P/E may look extremely large, but the company may still be cheap: FDX rose through $76 just 3 years later.

For this reason (and many others which we discussed here), investors should use average earnings when trying to determine a company's P/E, since earnings of one particular year (particularly a recessionary year such as this one) can be misleading.

By Saj Karsan

www.barelkarsan.com

About the author:

Saj Karsan
Saj Karsan founded an investment and research firm that is based on the principles of value investing. He has an MBA from the Richard Ivey School of Business, and an undergraduate engineering degree from McGill University.

Rating: 1.3/5 (6 votes)

Comments

Sivaram
Sivaram - 5 years ago
Using an average is one technique... another, the one I follow, is to treat cyclicals differently. For cyclicals, you want to buy them when the P/Es are high or infinite (loss). It's never perfect and the high P/E doesn't line up exactly with a low but, nevertheless, it's a rough guidepost.

I think transportation companies are heavily sensitive to the economy and are likely to be highly cyclical.

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