Follow The Rules

4. Relying On P/E Ratios Alone

If you lean toward value investing, one of the things you look for is a low price-to-earnings, or P/E, ratio--but it may not make sense to find those stocks whose P/Es are at their lowest historical level. Such stocks may have sunk for a reason, and they may be slow in returning to health. Instead, consider stocks with P/Es that are low relative to companies in the same industry but have had positive earnings in recent quarters. These stocks are more likely to rebound and make money than those that are really in the bargain basement.

The same goes for evaluating a mutual fund. While the names of some funds suggest they are value types, they may be investing in many momentum stocks (any fund that performed well in 1998, for example, had a large dose of technology stocks in it, no matter what the fund was called). Check its annual reports to be sure your fund provides the style you seek.

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This article was originally published in the January 2000 print edition of Entrepreneur with the headline: Follow The Rules.

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