About the Nasdaq 100's P/E Ratio

Also, the difference between "stated" book value and "tangible" book value.
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It's 1999, and so far I'm not impressed. All this technology on hand and I'm being held captive in my own home by a couple of feet of snow. Weren't we supposed to be zooming around in hovercrafts and actively colonizing the moon by now?

Oh well, at least by living out here on the frozen tundra I've got plenty of time answer queries and help jumpstart everyone's investment year. Let's begin with that question from last week that, much like Purdue's game winning TD against Kansas State in the Alamo Bowl, remains conspicuously unanswered.

The Hunt for an Index P/E

Would someone on the staff please calculate the P/E ratio of the Nasdaq 100 now that AMZN has been added to the index and report the results to your subscribers. Thanks, Larry Kimble

Larry:

As you may recall, I turned this one over to the readers for a little assist. While we didn't receive anything specific on the Nasdaq 100, one reader's insights on the Nasdaq Composite might prove valuable. I'll let her speak for herself.

Hi Andrew: Last I knew,

Barron's

carried the P/Es for at least the S&P and Dow in their dead tree versions. I read online these days, so I can't help you. Sorry. However, I did just get my morning email from Don Hays at Wheat First Union. In there he talks about the P/E on the Nasdaq: "As you know, we have been concerned with the S & P 500's all-time-record-high price-to-earnings ratio soaring to 32.19. But based upon our calculations this morning, the Nasdaq Composite makes that look dirt-cheap. Our calculated price-to-earnings ratio for the Nasdaq Composite is 90.2. That is not a typo." Hope that helps. -- Patricia L. Edwards, CFA, Vice President /Senior Portfolio Manager, Dynamic Capital Management

Thanks Patricia. It helps a lot.

For those interested in learning more about the latest changes to the Nasdaq 100 index, including recent additions and a technical description of the component weightings, check out the

Nasdaq Web site.

Tangible Issues

Could you please explain the difference, if there is any, between "stated" book value and "tangible" book value? Also, is it correct to assume that the stated book value does not overstate the actual price at which the companies' assets, minus liabilities, could be sold off? Thank you, Fred Sobel

Fred:

As I touched on in a previous article, firms that carry a lot of goodwill on their books due to previous acquisition activity are often accused of having an "inflated" book value. The idea is that "tangible" assets like big chunks of machinery or cases of Ginsu knives have some kind of liquidation value in the marketplace that "intangible" assets like goodwill do not. Consequently, abnormally high book values can lead to abnormally low valuation indicators like the price to book ratio. This low price to book could conceivably trick an unwary investor into thinking he or she is getting a screaming bargain when they may in fact not be.

Tangible net worth (or book value) is just the firm's stated book value reduced by the amount of intangible assets that they carry - namely goodwill. The figure arguably provides a more conservative look at the balance sheet than stated book value alone. For firms with high goodwill assets, the adjustment will be significant and likely drive that price to book ratio back to a more representative level.

In any case, neither calculation of book value should ever be construed as somehow equivalent to the liquidation value of the firm. Book value is simply an accounting measure and may or may not be representative of the market value of a firm's assets.

Writedown My Alley

When a company reports a writedown of, let's say, $100 million, assets (usually Property, Plant & Equipment) reduce by $100 million, but where is the reduction seen on the Liability and Stockholders' Equity side? I presume a reduction in equity (through lower retained earnings). Is that correct? -- Jason York

Jason:

You got it. A write-down refers to the process of reducing a portion of an asset's cost and is treated like an expense. On the income statement, this often shows up as a "nonrecurring" or "one-time" charge. In the end, it's subtracted from income, which impacts the Shareholder Equity section of the balance sheet.

A similar process is used for a write-

off

, but instead of just reducing an asset on the balance sheet like you do with a write

down

, the asset is eliminated altogether. It's often used to account for things like trashing obsolete inventories that can no longer be sold in the open market.

Armed and Dangerous

Hello Andrew! My question is about the Arms Index. I would like to know more about what it is and if it can be a useful tool for the small investor. Thanks, Kevin Mitchell

Kevin:

Looks like we've got another closet technician trying to slip into the "Fundy Forum." Nevertheless, I never pass up the chance to steal a little thunder from Gary B. Smith, so here goes:

The Arms Index, or short-term trading index, is calculated by dividing the Advance/Decline ratio by the Upside/Downside ratio. The formula looks like this: (Advancing Issues / Declining Issues) / (Advancing Volume / Declining Volume)

The figure basically indicates whether volume is flowing into advancing or declining stocks. If more volume is associated with advancing stocks than declining stocks, the figure will be greater than 1.0 (a bullish flag) and vice versa. Often times a moving average is used to smooth the short-term gyrations and make the index easier to interpret.

Regardless, the Arms Index is essentially a short-term trading tool designed to help time the market. As a result, its usefulness for small investors with a long-term orientation is minimal at best. If you're serious about accumulating significant wealth over the long, you'd be better off to spend your energy working hard at your chosen career, sock your money away into fundamentally solid stocks over the long run and leave the day trading to the retirees, the foolhardy, and other full-time devotees.

Haphazardous to Your Health

I am a totally haphazard investor and have the losses to show for it. How can I begin to make some sense out of it all in the (easiest way to understand)? I am constantly learning, but it is never enough. Please think about that and help! Thank you, Chris Dudley

Chris:

As you're finding, discipline is often the most important and difficult concept for the beginning investor to master. Unfortunately, it's one of those things you have to learn by doing. My advice is to get a plan - any plan - and stick with it over time instead of buying into every "whim of the week" that crosses your desk. You've got plenty of programs both here and in the Schoolhouse section to start with, including "Ben Graham's Lucky Seven," and my previous series on "The ABC's of Stock Picking."

In short, keep reading

TSC

and don't get discouraged. Even the best traders in the world realize that they'll never know everything, but they also know that they don't have to. They've just found a process that works for them and stuck with it year in and year out.

Keep those questions rolling in, send some warm vibes to us frozen Midwesterners, and I'll see you next week.

Andrew Greta is a business student and onetime stockbroker who lives in West Lafayette, Ind.