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Chapter 2. Trend Discovery: Finding the ... > Distinctions: Investment Value and C...

Distinctions: Investment Value and Current Market Value

The disparity of average returns between low-PE stocks and high-PE stocks is often related directly to core earnings adjustments. (See the example of Sears's stock, later in this chapter.) Based on what we have discovered about companies like Enron and WorldCom, it is reasonable to assume that there is a link between aggressive accounting policies and a stock's market price. Clearly, much of the run-up in those stocks' market price in the late 1990s was attributed to questionable accounting practices and financial reports. The performance-based compensation earned by many corporate officers acted as an incentive to inflate earnings. Stock prices and corresponding PE ratios were also distorted as a consequence.

Were the same corporate results subjected to core earnings adjustments, the outcome would surely have included far lower growth rates and more stable PE ratios. For the purpose of making realistic analysis possible, it all comes down to one question: What are the differences between current market value and long-term investment value? This is a key question; so much emphasis is placed on tracking price that it is easy to overlook the more significant and fundamental questions about what a company is really worth.


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