The Voice of Reason: Stock market crash of 2002 — or is it?

The Voice of Reason: Stock market crash of 2002 — or is it?

By By Tony Lamia

As I’ve watched TV reports by stock analysts over the years, I began to notice something very ominous. In the past, and for a long time, there were reports containing information about price/earnings ratios, dividend returns, and discussions about value. Analysts would recommend which stocks to buy, which to sell, and which to hold. But then, since the late1980’s all I heard was, “buy, buy, buy.” What changed?

Historically, the Dow Jones Industrial Average (“Dow”) ended each decade as follows:

1920-29: + 150% at about 250

1930-39: – 40% ~ 150

1940-49: + 47% ~ 220

1950-59: + 195% ~ 650

1960-69: + 19% ~ 775

1970-79: + 7% ~ 830

1980-89: + 237% ~ 2800

1990-99: + 321% ~ 11800

The largest gains occurred after 1985. The high point was around 11800 in January 2000.

Yesterday, July 19, 2002, the Dow fell to 8019—a decline since January 2000 of 32 percent! Since the Dow recovered from its setback after the 9/11 terrorist attacks, I believe this was due partly because investors lost confidence in corporate accounting, but more as a bursting of inflated prices created by greedy stock analysts.

Historically, the price/earnings (PE) ratio, typically, was between 10 and 14. Higher ratios mean higher prices and lower values. But lately, stock analysts have been suspiciously silent about this ratio—since around 1985! The coincidence between the sudden rise in stock prices and the missing PE statistics piqued my curiosity. So, I did some calculations, and guess what I found? Some hanky panky on Wall Street!

The PE ratio = price per share / per share earnings. Per share earnings = after tax profit / total number of outstanding shares. Thus, the value of the PE ratio is to link the stock price to the company’s earnings. This gives the investor a better assessment of the stock value.

But stock analysts don’t want you to make your own, informed decisions. They want you to rely on their “unbiased” advice. But how can they do that when their compensation is based on how much investment-banking business they generate? The more stocks you buy, the more money they make.

At what point in time did stock analysts go from independent researchers to stock salesmen? I could find no proof, but 1985 looks most likely. An article in the April 22, 2002, Business Week, on page 38, discloses e-mails between Merrill Lynch analysts that evidence deceit in their reports to the investing public. One e-mailer says, “The whole idea that we are independent from banking is a big lie.”

While the Dow rose through the roof, so did the PE ratio. But no one would talk about it on mainstream media. So, I did my own math (which is not scientific). On Sept. 7, 2001, the Dow closed at 9605. One reporter at that time happened to mention that the PE ratio was around 22.

Assuming that to be true, the Dow would have to drop to around 6,000 (1996 prices) just to equal the value of stocks at the upper end of the historical PE ratio of 14.

So, why don’t you hear much about PE ratios even now? I believe that Wall Street investment-bankers want the roller coaster ride to continue. If you are armed with knowledge (power), you will make wise decisions about your investment portfolio, and stock prices will become more stable. The purpose of the Voice of Reason newsletter is to empower you with knowledge. So, before you buy stock, get the PE ratio.

Tony L. Lamia is the author of “Blame It On The System.”