"P/E's Don't Matter"

Like many investors, I am naturally drawn to valuation as a measure of whether a stock or bond is an attractive investment or not.

Problem is, sometimes traditional valuation tools will lead you invest in areas that may look "cheap" based on numbers but lack any investment catalyst.

True growth stocks, on the other hand, may look expensive but can offer explosive returns to investors if their underlying growth rate justifies the multiple.

Case in point last year was Apple. Throughout the year, bears and worriers (put me in the latter camp) felt that Apple was trading at valuations that were too rich - but then AAPL was up nearly +60% last year.

My friend Bob Quinn has an expression for this. Whenever I mention to him that a stock is trading at a level that is too rich, he usually quickly says:

"P/E's don't matter."

Bob's being a little facetious, of course, since he looks at valuations also. No, what he really means is that I shouldn't simply ignore an investment idea because it looks expensive, or invest in a bond or stock because it looks too good to be true.

This morning's Financial Times had a good column (authored by James Mackintosh) about the Japanese stock market.

Talk about what seems to be a great opportunity!

For the last two decades Japanese stocks have gone nowhere, and the traditional valuation measures now appear quite compelling. Mr. Mackintosh explains:

...Forward price/earnings ratios...peaked at more than 70 {20 years ago} but now stand at 13.6 for the Topix index of the entire market. Leave aside the past few months, and they have been lower only once in the last 20 years, in 2008. ...Other measures make Japan look even cheaper. Prices are only just above book value, compared with double book in the US, and both price-to-cash flow and price-to-sales ratios are far lower than the US. Japan, renowned for decades for paltry dividends, now has a higher dividend yield than the US (although big US companies still yield slightly more).
You get the idea. If valuation alone is your investment driver, then Japan would be a big part of your investment strategy.

And yet, with the yen continuing to surge against the dollar, Japanese export growth will almost certainly continue to struggle, which will hurt the big Japanese multinational companies. It could instead turn out that the market is recognizing that earnings and profitability going forward will be less than expected, and that the Japanese stock market will remain a laggard relative to the rest of the world.

But I gotta confess: It sure looks tempting.