As part of our CEO Performance and Stock Price Trend Analysis we will now introduce two new
ratios: ratio f) and ratio g). Ratios a) through e) were defined in (link)
But first let's talk about why ratios are important. Basically ratios
are used to indicate average rates of change. If a given quantity y can be reasonably thought
of as depending upon or influenced by another quantity x, then the ratio y/x of y to x can be useful
in the determination of an average rate of change of the quantity y with respect to the quantity x.
The financial markets are dynamic entities. Therefore knowledge about rates of change are
potentially very useful.
Ralph N. Elliott published the basics of the Elliott Wave Theory in his book "The Wave
Principle" (1938). A basic premise of EWT is that crowd dynamics will drive the market from
highs to lows (in repeating cycles) in the process of reflecting the change of the aggregate sentiment
of the crowd from optimism to pessimism. It is the belief of the author that the governing
equations of the financial markets are similar in form to those of mathematical physics. One
of the basic equations of math physics is the wave equation. So it is not surprising that waves
also play an important part in economic affairs.
Many of the math concepts involved in EWT have been generalized by the present author.
So then in the presentation of his theory from time to time there may be an overlap of
certain generalizations of EWT in the context of the equations of math physics as applied
to econometrics and market dynamics (reduced to an accessible form of course).
The movement of stock prices between their lows and highs on a large time frame is most likely
related to those movements on a smaller time scale. The concept of Self - Similarity and analytical
tools such as fractals and "Elliott Fractals" will be brought into play in future analysis.
At this point an intuitive example of self - similarity in natural phenomena may be instructive.
The earth has a natural satellite that revolves around it every 29.5 days or so. The earth in turn
revolves around the sun on a yearly basis and, if you want to take it a little further, the sun
revolves around the galactic center. But getting back down to earth...
A detailed analysis may very well reveal that the frequency and amplitude with which stock prices
move between relative highs and lows, in say a 52 week period, are related to the frequency and
amplitude of those movements in smaller time intervals such as a month, a week, a day, or.... is
there such a thing as an "hour trader" or " 60 minute arbitrager"?
So then let's start with some simpler concepts and work our way up the ladder of complexity
and mastery of market dynamics. The ratio that we will designate as ratio f) was actually defined
in a previous posting. We defined the Intra Day Spread Ratio as follows:
intra day H - intra day L
Intra Day Spread Ratio = --------------------------------------
52 wk H - 52 wk L
This ratio is motivated by the self - similarity conceptual theme referred to above. This will
fluctuate from day to day (and stock to stock) but the pattern of fluctuation can be analyzed.
Now to the second ratio being introduced today. We will designate it as ratio g). This will
hopefully be a useful refinement of the familiar P/E ratio. We will identify the
new ratio as the "Dynamic P/E Ratio", but first it would be fruitful to review the meaning of the
P/E. Suppose that for the most recently completed quarter a stock had earning of $2.25 per
share. Suppose further that the stock is now selling at around $45.00 per share. The P/E is
calculated by simply taking the ratio of price to earnings
P/E = $45/$2.25 = $20/$1 = 20/1 = 20
The utility of this ratio is limited by the fact that it is not "temporally balanced". So consequently
it would not be correct to say that for each $1 increase in earnings there is a corresponding $20
increase in price! The reason for that is the fact that the time intervals for the price and the earnings
are not the same. The $2.25 was earned totally within the most recent quarter (hereafter we will
write briefly mrq for most recent quarter) but the $45 price was not "completely established" during
the mrq. In other words the price of the stock was most likely not zero at the beginning of the previous
What would be better is a ratio of related changes: the ratio of the change in price
(from quarter to quarter) to the change in quarterly earnings (from quarter to quarter).
Admittedly such a new ratio will be static, on a quarter to quarter basis (because it will be calculated
only quarterly), but more importantly the time intervals of the numerator and the denominator will be
balanced and accordingly such a metric should be much more accurate in expressing the rate of stock
price changes with respect to changes in earnings. It should have utility as one of the tools that would
be used in forecasting stock prices a quarter in advance.
But there is a fine point that we must address. The corporate quarterly reports are not published
simultaneously with the ending of the quarter: to the surprise of no one. So except for the guidance
provided by analysts, the investing public has to wait before getting the official results. The lag can vary
from stock to stock but most quarterly reports are published at least within three calendar weeks
after the end of the quarter.
So then with the above thoughts in mind we will now define the "Dynamic Price To Earnings Ratio",
designated by, DP/E, as follows:
change in stock price during the prev. "shifted quarter"
change in quarterly earnings
where the "shifted quarter" is the (roughly) quarter of a year period that ends three weeks after the
end of the fiscal quarter and begins three weeks after the beginning of the fiscal quarter.
So then the shifted quarter that corresponds to the fiscal quarter that ends June 30, will end
on July 21 (or thereabout) and it will begin on April 21 (or thereabout).
We may equivalently define the DP/E as follows:
stock price at end of mrsq - stock price at beginning of mrsq
earnings in mrq - earnings in quarter prior to mrq
where the abbreviation "mrsq" stands for the "most recent shifted quarter".
Note: we were speaking of waves earlier. The reader who remembers a bit of trigonometry
will recall that the sine and cosine waves (graphs of the functions) may be obtained from
each other by a shift of 90 degrees. So shifts are not out of place in Financial Analysis.
A Break For Humor
Shifts are fine gifts to the smart market technician
but acting upon an inside informational tip
could earn an Insider a trip to the correctional kitchen!
Where Martha was cooking Stew...
So if your information is not as fresh as that of the CEO
just remember that he can't immediately make a profit
on all that he does know
or he might end up doing the same thing too!
Who will get a taxi - cab lift to the next kitchen shift (?)!
Do they allow them to arrive in limo's ?
We usually give specific examples and /or illustrations for the concepts being defined, but this
time we will defer until early next week when we will (with examples) calculate all of the ratios a)
through g) for several Dow Components in an easy to read tabular format.
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