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Lower is better

Ask the Fool

Published: January 14, 2020

Q: Is it better for a company's forward price-to-earnings (P/E) ratio to be higher or lower than its current P/E ratio? -- H.D., Springfield, Illinois
A: Lower is generally better. The current P/E ratio is the company's current stock price divided by its earnings per share (EPS) for the trailing 12 months -- so it's backward-looking. The forward, or projected, P/E ratio divides the stock price by next year's estimated EPS.
When the forward P/E ratio is lower than the current one, it reflects that earnings are expected to rise. For example, if the Whoa, Nellie Brake Co. (ticker: HALTT) is trading at $60 per share with EPS over the past year of $3, its P/E would be 60 divided by 3, or 20. If it's expected to generate $4 in EPS next year,
A lower forward P/E is promising, but it might just be due to unusually low earnings in the past year. And earnings estimates sometimes turn out to be wrong. Never make any investment decision based on just one measure, or even just a few.
Q: How does one begin researching a company? -- L.F., Pensacola, Florida
A: Call and ask its Investor Relations department to send you an "investor's package," which should feature the latest annual and quarterly reports and usually more.
Better still, gather that information -- and more -- online, starting with the company's website. Most major companies have very informative websites; check out sections with labels like "About Us," "For Investors" and "News."
Presentations made by executives can be very informative. You can also look up news reports and articles using Google Search and Google News.
Fool's School
When Recessions Hit
A recession is in progress when we have two or more consecutive quarters of shrinking gross domestic product (GDP) growth. Occasional economic downturns -- recessions -- are inevitable. On average, they happen about every five years, which makes us overdue for one now. They can cause financial distress, but they're not all bad. Here's what to expect when one occurs:
-- Stocks will fall in value, often by 20% to 30%, but sometimes by as much as 50%. The market has always eventually recovered from recessions -- sometimes within one year, but usually within a few.
-- Interest rates, including those for credit cards, often fall. That's good news for those borrowing to buy a home or car, or refinancing their debt.
-- Many bond prices rise. This is generally true for the safest bonds -- Treasuries -- and to a lesser degree for high-quality corporate bonds. Junk bonds aren't likely to fare well, though.
-- Home prices hold steady or even rise during most recessions.
-- Inflation often pulls back, effectively lowering prices, since many expenses fall. That can make a recession a good time to make a large purchase, such as a new car or a major appliance.
-- Unemployment tends to rise. During the Great Recession of 2007 to 2009, unemployment nearly doubled, from 5% to 9.5%.
No two recessions will be exactly alike, but history suggests that there are often silver linings amid the disruption. You can brace for a recession by having a well-stocked emergency fund that can cover all important expenses for six to nine months. It can also be smart to have some healthy dividend-paying stocks in your portfolio, as they will likely keep kicking out income in good times and bad.
Most importantly, simply expect occasional economic downturns, and don't panic. If you can have some extra cash on hand, recessions can be great times to buy stocks.
My Smartest Investment
A Financial Dead Weight
My smartest financial move was prepaying about 4% of the value of my home loan. This reduced my loan-to-value ratio enough to drop the private mortgage insurance (PMI) my lender had required me to carry. Since PMI isn't even deductible, it was a financial dead weight. Good riddance! -- U.L., online
The Fool responds: Homebuyers are generally required to carry PMI when they buy a home with less than a 20% down payment. That 20% can be a hefty sum -- it's $50,000 if you're buying a $250,000 home -- so it's common for borrowers to pay for PMI along with their regular mortgage payments.
As you make payments over time and build equity in your home, your loan-to-value ratio will drop, and once the principal you owe drops to 80% of the home's value, you can ask your lender to cancel the PMI. To maximize your chances of getting it canceled, make your payments on time. (Even if you don't get around to asking, once your loan-to-value ratio hits 78%, if you're current on your payments, your lender will be required to cancel it.)
Making extra payments against principal on your mortgage is often a great idea, as just an extra payment or two per year can shave many years off the life of your loan.
Foolish Trivia
Name That Company
I trace my roots back to Texas in 1968, when a family business was launched to sell wigs. Wigs soon fell out of fashion, though, so I shifted toward hair-styling tools. I licensed the Vidal Sassoon brand in the 1980s, very profitably. I added more brands under my umbrella over the years, including OXO, Hydro Flask, Vicks, Braun, Honeywell, PUR and Hot Tools. I'm based in Bermuda, with close to 1,500 employees and a market value that recently topped $4 billion. My mythical namesake was daughter to Zeus and a cause of the Trojan War. Who am I?
Last Week's Trivia Answer
I came to life in 2006, offering an innovative way to house-hunt, and within three days had attracted more than 1 million visitors. I went public in 2011, with my shares soaring almost 79% on that first day. I bought my rival, Trulia, in 2015. Based in Seattle, I'm now home to a group of companies, including apartment marketplaces and an online mortgage company. In my last reported quarter, I bought 2,291 homes and sold 1,211. I had 2.1 billion visits, from nearly 200 million unique monthly visitors. My market value was recently near $8 billion. Who am I? (Answer: Zillow Group)
The Motley Fool Take
Gushing About Chevron
2019 has been another tough year for oil producers, which are dependent on oil prices. A rally early in the year gave way to a decline, as fears over a slowing global economy caused oil prices to retreat -- taking many oil stocks with them. Integrated oil major Chevron (NYSE: CVX) is one energy stock that has taken a beating, yet has barely skipped a beat.
Oil prices are down a bit from their spring 2019 highs, and Chevron's revenue is down 8% over the last 12-month stretch, but its free cash flow has remained relatively stable. The company is financially solid, with relatively little debt -- indeed, it has plenty of room on its balance sheet to add debt if an industry downturn requires it.
Chevron looks well-positioned in the oil industry, with relatively low costs, growing production and a strong enough balance sheet to handle adversity. Of course, oil and natural gas are carbon-based fuels that are expected to be displaced over time by cleaner alternatives, like electricity generated by solar and wind -- though that won't happen suddenly. Right now, the world still needs oil and gas -- in large quantities.
Long-term investors looking for a reliable dividend stock should consider Chevron. It isn't a risk-free investment, but its dividend yield (recently 4%) is attractive, and the dividend continues to grow. This seems a good time to consider adding Chevron to your dividend portfolio.