Diane:
At 08:57 PM 12/30/2004, you wrote:
The Portfolio Report Card Overview section of Toolkit 5 has a new concept,
called rational value. I'm trying to understand how the the number is
calculated.
You should be able to arrive at it by dividing the current price of
each stock by its relative value and multiplying that result by the
number of shares.
The concept behind this value is that each company has a fairly
constant PE (we like to call it the "signature PE") at which it has
sold. This is its historical average and represents a price (expressed
as a multiple of earnings) that has proven to be reasonable. The PE
is a rate investors are willing to pay for a dollar's worth of earnings
(much like the price or rate for a pound of coffee or gallon of gas).
When the PE is above that signature PE, it's selling at a higher rate
than "normal" and, conversely, when it sells below that value, it's
selling at a lower than "normal" rate.
The "Rational Price" (current price divided by the Relative Value)
is the price at which the stock would be selling were it to have
a Relative Value of 100%. In other words, it's the "normal" price
for the stock based on history. The "Rational Value" is the value
of your holdings if people were to be paying that "rational" price
for the stock.
The value is in setting a realistic value on your portfolio so that
you can see if, in the present market, your portfolio and its
holdings are above or below what it "should" be if people were
paying that rational price. It's supposed to keep you feet on the
ground in a bubble and your head in the clouds in a bust. <g>
Ellis Traub
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