3

For stocks, I can easily look at the price/earnings ratio, and, according to The Intelligent Investor, stand clear of those with a ratio higher than 20.

How can I tell if the current price of an ETF is a good price to buy it? Are there such simple metrics?

6

In contrast to D Stanley's answer, there is a well-defined concept of P/E for a stock ETF:

We take all the money earned by all the companies in a portfolio—positive and negative—and use that as the divisor against the total market cap of the portfolio (all weighted by the positions value in a portfolio, of course).

That way, the Twitters offset the J.P. Morgans, and you create a kind of “what if this was all one company” view of the real earning power of the entire pool of stocks, relative to how the market is valuing them.

Just as the P/E of a single stock is the company's market cap divided by its total earnings, the P/E of an ETF is the ETF's market cap divided by the total earnings attributable to the shares held by the ETF (e.g., if the ETF owns 1% of the outstanding shares of XYZ then we count 1% of company XYZ's earnings). An equivalent expression is

(E/P of ETF) = sum of (weighting of stock i) * (E/P of stock i),

where E/P is the inverse of P/E. (In the special case of a market-cap-weighted ETF, the P/E reduces to simply the sum of all the companies' market caps divided by the sum of all their total earnings.)

This works even when the earnings of some component stocks are negative. Sometimes negative P/Es (or E/Ps) are not considered meaningful, but they can be used in the above formula as is. In fact, ETFs are less likely to have negative overall P/Es, because the weighted total earnings over a diversified set of stocks are likely to be positive (unless it is an ETF for a specific sector that is truly in the dumps).

  • Thanks, this looks just like what I was looking for. I had a hard time googling "e/p ratio" - it would always get "corrected" to "p/e ratio", so after a bit of struggling, I found out that it's also referred to as "earnings yield". Perhaps that would be worth noting in your answer. – Zoltán Jun 30 '18 at 17:54
2

P/E ratio for an ETF is much less informative than it is for stocks, because prices are not directly comparable (a ETF with a $20 price is not necessarily "cheaper" than one with a $100 price), and the "Earnings" of a fund are not as simple as they are for the underlying stocks.

Instead, what you focus on is the historical return. ETFs contain hundreds of underlying stocks, so a "share" is not as easy to conceptualize as a share of a company with assets that a shareholder owns a portion of. Instead, a share of an ETF gives the owner a portion of ownership of a massive investment pool. The value of the pool should determine most of the price of the fund, but since the fund shares are traded, they are subject to market forces, and the market might place a premium or discount on the ETF prices for a short time.

You can also look at the historical risk, or amount of swing you might expect in the price of the fund. Like any investment, the higher the risk, the higher the expected return you should expect (since otherwise you'd choose a less risky fund for the same expected return). However, that risk also means that the losses might be higher then other less risky investments.

Finally, look at the fees the funds charge. The fees directly reduce the return, so a fund with higher fees should have higher returns to compensate for the fees.

Your Answer

By clicking "Post Your Answer", you acknowledge that you have read our updated terms of service, privacy policy and cookie policy, and that your continued use of the website is subject to these policies.

Not the answer you're looking for? Browse other questions tagged or ask your own question.