Joe:
At 02:24 PM 1/4/2008, you wrote:
>I am very comfortable with the conservative aproach built into Take
>Stock. I understand the need to cap the high PE forecast to maintain a
>certain amount of realism. Where I am having difficulty is in
>understanding the logic on the formula to reduce the forecast low PE.
>Please excuse my ignorance, I am new to the fundamental side, up to
>now I have mostly used technical analysis.
We needed a mechanism that would produce a reasonable but moderate result. It seemed to me a rational approach to look at the relationship between the high and low PE before the high was capped at 30 and to reduce the low PE to the same relationship to the capped PE.
We also looked at the prospect of using a PEG ratio of 1 for the low PE. However, in practice, looking at the results, it seemed to me that the choice we made was the better and more rational one.
The low PE is our means of arriving at a potential low price. We look at the lowest earnings we might expect and the lowest multiple of those earnings people might be expected to pay in the future, based on their historical practice (and moderated to be comfortable and sustainable).
By providing us with a mechanism with which we can consistently come up with the future price range, we then make the Upside/Downside Ratio much more useful than simply as a measure of "risk." We use the U/D ratio to assess how our evaluation of the company's quality and worth stacks up to "the herd's." If we have overvalued it compared to what the herd thinks, we come up with a low U/D ratio, which is an alarm that prompts us to go back and challenge our assumptions by which we came up with the quality judgments.
I hope that helps some more. You might want to read my book, Take Stock: A Roadmap to Profiting from you First Walk Down Wall Street. I pretty much cover all of this there.
ET