How useful is the PEG Ratio for large cap stocks?
It is not so useful because you are applying it to large capital. Think about Theory of Investment Value. It says that you must find undervalued stocks with whatever ratios and metrics. Now think about the reality of a company. For example, if you are waiting KO (The Coca-Cola Company) to be undervalued for buying it, it might be a bad idea because KO is already an international well known company and KO sells its product almost everywhere...so there are not too many opportunities for growth. Even if KO ratios and metrics says it's a good time to buy because it's undervalued, people might not invest on it because KO doesn't have the same potential to grow as 10 years ago. The best chance to grow is demographics. You are better off either buying ETFs monthly for many years (10 minimum) OR find small-cap and mid-cap companies that have the potential to grow plus their ratios indicate they might be undervalued. If you want your investment to work remember this: stock price growth is nothing more than You might ask yourself. What is your investment profile? Agressive? Speculative? Income? Dividends? Capital preservation? If you want something not too risky: ETFs. And not waste too much time. If you want to get more returns, you have to take more risks: find small-cap and mid-companies that are worth. I hope I helped you!
Well Company is a small assets company for example it has 450,000,000 shares outstanding and is currently traded at .002. Almost never has a bid price.  Compare it to PI a relative company with 350 million marker cap brokers will buy your shares.  This is why blue chip stock is so much better than small company because it is much more safer. You can in theory make millions with start up / small companies.  You would you rather make stable medium risk investment than extremely high risk with high reward investment  I only invest in medium risk mutual funds and with recent rallies I made 182,973 already in half year period. There are the EDHEC-risk indices based on similar hedge fund types but even then an IR would give you performance relative to the competition, which is not useful for most hf's as investors don't say I want to buy a global macro fund, vs a stat arb fund, investors say I want to pay a guy to give me more money!  Most investors don't care how the OTHER funds did or where the market went, they want that NAV to go always up , which is why a modified sharpe is probably better. "You'll generally get a number close to market cap of a mature company if you divide profits (or more accurately its free cash flow to equity) by the cost of equity which is usually something like ~7%.    The value is meant to represent the amount of cash you'd need to generate investment income off it matching the company you're looking at. Imagine it as asking ""How much money do I need to put into the bank so that my interest income would match the profits of the company I'm looking at"". Except replace the bank with the market and other forms of investments that generate higher returns of course and that value would be lower." No, this is quite wrong. Almost all hedge funds (and all hedge fund investors) use Sharpe as a *primary* measure of performance. The fact that they don't consider themselves risk-free has no bearing on the issue (that's a bizarre line of reasoning - you're saying Sharpe is only relevant for assets that consider themselves risk-free?). And as AlphaPortfolio rightly points out, most funds have no explicit benchmark and they are usually paid for performance over zero.  I've never seen a hedge fund use a benchmark relative information ratio - for starters, what benchmark would you measure a CB arb fund against? Or market neutral quant? Or global macro? Same for CTAs... It sounds to me like you may not be defining fundamental investing very well, which is why it may seem like it doesn't matter.  Fundamental investing means valuing a stock based on your estimate of its future profitability (and thus cash flows and dividends).  One way to do this is to look at the multiples you have described.  But multiples are inherently backward-looking so for firms with good growth prospects, they can be very poor estimates of future profitability. When you see a firm with ratios way out of whack with other firms, you can conclude that the market thinks that firm has a lot of future growth possibilities.  That's all. It could be that the market is overestimating that growth, but you would need more information in order to conclude that.  We call Warren Buffet a fundamental investor because he tends to think the market has made a mistake and overvalued many firms with crazy ratios.  That may be in many cases, but it doesn't necessarily mean those investors are not using fundamental analysis to come up with their valuations. Fundamental investing is still very much relevant and is probably the primary determinant of stock prices.  It's just that fundamental investing encompasses estimating things like future growth and innovation, which is a lot more than just looking at the ratios you have described. I would think there would be heavy overlap between companies that do well and market cap. You're not going to get to largest market cap without being well managed, or at least in the top percentile. After all, in a normal distribution, the badly managed firms go out of business or never get large. The biggest benefit to having a larger portfolio is relatively reduced transaction costs. If you buy a $830 share of Google at a broker with a $10 commission, the commission is 1.2% of your buy price.  If you then sell it for $860, that's another 1.1% gone to commission.  Another way to look at it is, of your $30 ($860 - $830) gain you've given up $20 to transaction costs, or 66.67% of the proceeds of your trade went to transaction costs. Now assume you traded 10 shares of Google. Your buy was $8,300 and you sold for $8,600.  Your gain is $300 and you spent the same $20 to transact the buy and sell.  Now you've only given up 6% of your proceeds ($20 divided by your $300 gain). You could also scale this up to 100 shares or even 1,000 shares. Generally, dividend reinvestment are done with no transaction cost.  So you periodically get to bolster your position without losing more to transaction costs.  For retail investors transaction costs can be meaningful.  When you're wielding a $5,000,000 pot of money you can make your trades on a larger scale giving up relatively less to transaction costs. I think it's safe to say that Apple cannot grow in value in the next 20 years as fast as it did in the prior 20. It rose 100 fold to a current 730B valuation. 73 trillion dollars is nearly half the value of all wealth in the world.  Unfortunately, for every Apple, there are dozens of small companies that don't survive. Long term it appears the smaller cap stocks should beat large ones over the very long term if only for the fact that large companies can't maintain that level of growth indefinitely.  A non-tech example - Coke has a 174B market cap with 46B in annual sales. A small beverage company can have $10M in sales, and grow those sales 20-25%/year for 2 decades before hitting even $1B in sales. When you have zero percent of the pie, it's possible to grow your business at a fast pace those first years. Thanks. Just to clarify I am looking for a more value-neutral answer in terms of things like Sharpe ratios. I think it's an oversimplification to say that on average you lose money because of put options - even if they expire uselessly 90% of the time, they still have some expected payoff that kicks in 10% of the time, and if the price is less than the expected payoff you will earn money in the long term by investing in put options (I am sure you know this as a PhD student I just wanted to get it out there.)I guess more formally my question would be are there studies on whether options prices correspond well to the diversification benefits they offer from an MPT point of view. The Sharpe ratio is, perhaps, the method you are looking for.  That said, not really sure beta is a meaningful metric, as there are plenty of safe bets to be made on volatile stocks (and, conversely, unsafe bets to be made on non-volatile ones). "Below is just a little information on this topic from my small unique book ""The small stock trader"":  The most significant non-company-specific factor affecting stock price is the market sentiment, while the most significant company-specific factor is the earning power of the company. Perhaps it would be safe to say that technical analysis is more related to psychology/emotions, while fundamental analysis is more related to reason – that is why it is said that fundamental analysis tells you what to trade and technical analysis tells you when to trade. Thus, many stock traders use technical analysis as a timing tool for their entry and exit points. Technical analysis is more suitable for short-term trading and works best with large caps, for stock prices of large caps are more correlated with the general market, while small caps are more affected by company-specific news and speculation…: Perhaps small stock traders should not waste a lot of time on fundamental analysis; avoid overanalyzing the financial position, market position, and management of the focus companies. It is difficult to make wise trading decisions based only on fundamental analysis (company-specific news accounts for only about 25 percent of stock price fluctuations). There are only a few important figures and ratios to look at, such as: perhaps also: Furthermore, single ratios and figures do not tell much, so it is wise to use a few ratios and figures in combination. You should look at their trends and also compare them with the company’s main competitors and the industry average. Preferably, you want to see trend improvements in these above-mentioned figures and ratios, or at least some stability when the times are tough. Despite all the exotic names found in technical analysis, simply put, it is the study of supply and demand for the stock, in order to predict and follow the trend. Many stock traders claim stock price just represents the current supply and demand for that stock and moves to the greater side of the forces of supply and demand.  If you focus on a few simple small caps, perhaps you should just use the basic principles of technical analysis, such as:  I have no doubt that there are different ways to make money in the stock market. Some may succeed purely on the basis of technical analysis, some purely due to fundamental analysis, and others from a combination of these two like most of the great stock traders have done (Jesse Livermore, Bernard Baruch, Gerald Loeb, Nicolas Darvas, William O’Neil, and Steven Cohen). It is just a matter of finding out what best fits your personality.  I hope the above little information from my small unique book was a little helpful! Mika (author of ""The small stock trader"")" Most of the “recommendations” are just total market allocations.  Within domestic stocks, the performance rotates. Sometimes large cap outperform, sometimes small cap outperform. You can see the chart here (examine year by year):  https://www.google.com/finance?chdnp=1&chdd=1&chds=1&chdv=1&chvs=maximized&chdeh=0&chfdeh=0&chdet=1428692400000&chddm=99646&chls=IntervalBasedLine&cmpto=NYSEARCA:VO;NYSEARCA:VB&cmptdms=0;0&q=NYSEARCA:VV&ntsp=0&ei=_sIqVbHYB4HDrgGA-oGoDA Conventional wisdom is to buy the entire market. If large cap currently make up 80% of the market, you would allocate 80% of domestic stocks to large cap.  Same case with International Stocks (Developed). If Japan and UK make up the largest market internationally, then so be it.  Similar case with domestic bonds, it is usually total bond market allocation in the beginning.  Then there is the question of when you want to withdraw the money. If you are withdrawing in a couple years, you do not want to expose too much to currency risks, thus you would allocate less to international markets. If you are investing for retirement, you will get the total world market.  Then there is the question of risk tolerance. Bonds are somewhat negatively correlated with Stocks. When stock dips by 5% in a month, bonds might go up by 2%. Under normal circumstances they both go upward. Bond/Stock allocation ratio is by age I’m sure you knew that already.  Then there is the case of Modern portfolio theory. There will be slight adjustments to the ETF weights if it is found that adjusting them would give a smaller portfolio variance, while sacrificing small gains. You can try it yourself using Excel solver.  There is a strategy called Sector Rotation. Google it and you will find examples of overweighting the winners periodically. It is difficult to time the rotation, but Healthcare has somehow consistently outperformed. Nonetheless, those “recommendations” you mentioned are likely to be market allocations again.  The “Robo-advisors” list out every asset allocation in detail to make you feel overwhelmed and resort to using their service. In extreme cases, they can even break down the holdings to 2/3/4 digit Standard Industrial Classification codes, or break down the bond duration etc.  Some “Robo-advisors” would suggest you as many ETF as possible to increase trade commissions (if it isn’t commission free). For example, suggesting you to buy VB, VO, VV instead a VTI. There is some convergence, but the chart seems to indicate that 5 star funds end up on the upper end of average (3 stars) whereas 1 star funds end up on the lower end of average (1.9 stars) over the long term. I would have thought that the stars would be completely useless as forward looking indicators, but they seem to have been slightly useful? This is Rob Bennett, the fellow who developed the Valuation-Informed Indexing strategy and the fellow who is discussed in the comment above. The facts stated in that comment are accurate -- I went to a zero stock allocation in the Summer of 1996 because of my belief in Robert Shiller's research showing that valuations affect long-term returns. The conclusion stated, that I have said that I do not myself follow the strategy, is of course silly. If I believe in it, why wouldn't I follow it? It's true that this is a long-term strategy. That's by design. I see that as a benefit, not a bad thing. It's certainly true that VII presumes that the Efficient Market Theory is invalid. If I thought that the market were efficient, I would endorse Buy-and-Hold. All of the conventional investing advice of recent decades follows logically from a belief in the Efficient Market Theory. The only problem I have with that advice is that Shiller's research discredits the Efficient Market Theory. There is no one stock allocation that everyone following a VII strategy should adopt any more than there is any one stock allocation that everyone following a Buy-and-Hold strategy should adopt. My personal circumstances have called for a zero stock allocation. But I generally recommend that the typical middle-class investor go with a 20 percent stock allocation even at times when stock prices are insanely high. You have to make adjustments for your personal financial circumstances. It is certainly fair to say that it is strange that stock prices have remained insanely high for so long. What people are missing is that we have never before had claims that Buy-and-Hold strategies are supported by academic research. Those claims caused the biggest bull market in history and it will take some time for the widespread belief in such claims to diminish. We are in the process of seeing that happen today.  The good news is that, once there is a consensus that Buy-and-Hold can never work, we will likely have the greatest period of economic growth in U.S. history. The power of academic research has been used to support Buy-and-Hold for decades now because of the widespread belief that the market is efficient. Turn that around and investors will possess a stronger belief in the need to practice long-term market timing than they have ever possessed before. In that sort of environment, both bull markets and bear markets become logical impossibilities. Emotional extremes in one direction beget emotional extremes in the other direction. The stock market has been more emotional in the past 16 years than it has ever been in any earlier time (this is evidenced by the wild P/E10 numbers that have applied for that entire time-period). Now that we are seeing the losses that follow from investing in highly emotional ways, we may see rational strategies becoming exceptionally popular for an exceptionally long period of time. I certainly hope so! The comment above that this will not work for individual stocks is correct. This works only for those investing in indexes. The academic research shows that there has never yet in 140 years of data been a time when Valuation-Informed Indexing has not provided far higher long-term returns at greatly diminished risk. But VII is not a strategy designed for stock pickers. There is no reason to believe that it would work for stock pickers. Thanks much for giving this new investing strategy some thought and consideration and for inviting comments that help investors to understand both points of view about it. Rob "Maria, there are a few questions I think you must consider when considering this problem. Do fundamental or technical strategies provide meaningful information? Are the signals they produce actionable? In my experience, and many quantitative traders will probably say similar things, technical analysis is unlikely to provide anything meaningful. Of course you may find phenomena when looking back on data and a particular indicator, but this is often after the fact. One cannot action-ably trade these observations. On the other hand, it does seem that fundamentals can play a crucial role in the overall (typically long run) dynamics of stock movement. Here are two examples, Technical: suppose we follow stock X and buy every time the price crosses above the 30 day moving average. There is one obvious issue with this strategy - why does this signal have significance? If the method is designed arbitrarily then the answer is that it does not have significance. Moreover, much of the research supports that stocks move close to a geometric brownian motion with jumps. This supports the implication that the system is meaningless - if the probability of up or down is always close to 50/50 then why would an average based on the price be predictive? Fundamental: Suppose we buy stocks with the best P/E ratios (defined by some cutoff). This makes sense from a logical perspective and may have some long run merit. However, there is always a chance that an internal blowup or some macro event creates a large loss.  A blended approach: for sake of balance perhaps we consider fundamentals as a good long-term indication of growth (what quants might call drift). We then restrict ourselves to equities in a particular index - say the S&P500. We compare the growth of these stocks vs. their P/E ratios and possibly do some regression. A natural strategy would be to sell those which have exceeded the expected return given the P/E ratio and buy those which have underperformed. Since all equities we are considering are in the same index, they are most likely somewhat correlated (especially when traded in baskets). If we sell 10 equities that are deemed ""too high"" and buy 10 which are ""too low"" we will be taking a neutral position and betting on convergence of the spread to the market average growth. We have this constructed a hedged position using a fundamental metric (and some helpful statistics). This method can be categorized as a type of index arbitrage and is done (roughly) in a similar fashion. If you dig through some data (yahoo finance is great) over the past 5 years on just the S&P500 I'm sure you'll find plenty of signals (and perhaps profitable if you calibrate with specific numbers). Sorry for the long and rambling style but I wanted to hit a few key points and show a clever methods of using fundamentals."