Avoiding the Traps of Being Early: Value on the Move Screens
by Wayne A. Thorp
The early bird gets the worm, but the second mouse gets the cheese. Although this saying is identified with a New York City entertainer, it is apropos for value investors, who typically seek to get in early on worthy stocks but who need to avoid the traps set by unworthy stocks.
Numerous studies have shown that value-oriented investing is more profitable than most other strategies over the long term. Value screens, such as a price-earnings screen, tend to look for low prices relative to actual measures of company performance, in this case earnings per share. A screen that looks only for low price-earnings stocks, however, can also be a trap with unintended results.
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Typically, firms with high growth potential trade at high(er) price-earnings ratios, while those with low growth potential trade at low(er) price-earnings ratios. As a result, a screen that simply seeks stocks with low price-earnings ratios may leave you with a list of companies that have little or no growth prospects, or stocks concentrated in industries with low price-earnings ratios.
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