I found Harrison Freund's column "Reversion to the Mean" pointlessly simplistic and unacceptable. He does such a good job discrediting his own illogical statements that it is a wonder why he wrote the article in the first place.
Rather than present value investing in its true light, he lumps all its iterations into reversion theory, name-dropping great investors who no doubt do a lot more research than checking P/E ratios against historical values. Then he proceeds to give the excellent Nikkei index example, which renders historical reversion theory false.
Why is it false? The P/E ratio is a growth multiple. Different historical periods have different growth prospects. Recent history suggests much higher P/E ratios due to globalization and expansion into foreign markets. As these markets become saturated, P/E ratios logically would fall across the board.
What is essentially tragic about the column is how close he is to theories that make some legitimate sense. Conclusions about comparative valuation can be employed properly but only when compared to current sector averages. If the Standard & Poor's 500 were trading at a standard P/E of 13, that is the benchmark against which basic valuations ought to be compared, not a historical value of 16. More directly, stocks' P/E ratios ought to be compared to stocks of competitors, not the market as a whole since some sectors with smaller growth prospects do not trade close to the market average.
So P/E valuation might give you some clues to work with, yes, but if you are planning on investing real money it is a good idea to do some actual research on selected companies rather than trusting a faith-based theory.
Kurt Jensen\nCLAS I
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