RELATED TOPIC ---> | CHAPTER ONE : Introduction and 12 Month Exercise |

RELATED TOPICS --> | Relationship between individual share P/E & subsequent returns |
                               | Best performing P/E ratios since the 2003 Crash |

This is the second part of the research that documents findings on the relationship between the ALSH index's P/E ratios and subsequent returns. It is premium content for subscribers only.

2. CHAPTER TWO : 6 MONTH EXERCISE

The chart below shows the 6-month ALSH returns for various daily observed P/E's for the ALSH index for the last 16 years (over 4,034 daily observations since 1994, slightly more than the 12-month exercise in Part-1.)



The similar exercise as the first section conducted for subsequent 6-month growth periods (as opposed to 12 in previous section) is equally illuminating. Whilst subsequent 6-month returns for various P/E's are 40%-50% lower than subsequent 12-month returns (showing how time in the market is as important as timing the market) the overall trend remains.

Note however, that P/E's ranging from 17-18 (the "Sweet Spot" in previous example) are likely to offer negligible to negative returns for the ALSH over 6 months as opposed to 12% annual returns. Again, PE's less than or equal to 11 are likely to offer bang for you buck in the short term as well as the long (12 month) term.

For 6-month investing horizons, the "Sweet Spot" seems to be PE ranges from 14-15 which offer 86.9% positive historical results with a 11.5% average return (almost identical to the 12-month "sweet spot" which yielded 12.0%) This range had a deviation of 10.4% offering a Sharpe of 1.1, identical to the 12-month periods "sweet spot."

Investing when the JSE's PE is above or equal to 18 is still a bad idea even over shorter term horizons like 6 months.

The right chart shows that there is actually a stronger correlation between PE and 6-month returns, with a correlation coefficient of -0.295 as opposed to -0.21 in the 12-month exercise.

3. CONCLUSION
There is solid evidence for a correlated relationship between the ALSH's PE ratio and subsequent 6 and 12 month returns.

Periods when the JSE is showing a PE of less than or equal to 12 should be grabbed eagerly with open arms.

Making new investments during periods when the JSE is showing PE's of 18 and above should be avoided.

This study examined P/E ratios of the ALSH index itself as a composite index. Just because the JSE is sitting at a PE of 20 does not mean that a good share at a PE of 10 should be avoided. However bear in mind that a tide floats all boats and if the JSE does suffer a correction as a result of a inflated P/E ratio then chances are strong the share in question "may" move down in sympathy. Remember, logic and sense do NOT come into play in corrections, especially steep ones where wanton indiscriminate selling occurs on most shares.

Of course these are just statistics and probabilities based on investing in the ALSH index (or the TOP40 for that matter) and do not take into account external factors such as the economy, liquidity, individual share situations etc. but nevertheless is very interesting quantitative food for thought to offer a backdrop to your overall and even individual share purchase decisions. 

RELATED TOPIC ---> | CHAPTER ONE : Introduction and 12 Month Exercise |

RELATED TOPICS --> | Relationship between individual share P/E & subsequent returns |
                               | Best performing P/E ratios since the 2003 Crash |
 
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