In a bid to have more money to pay rent or service student loans – but very much not to buy more avocado toast – the UK’s cash-strapped millennial generation are seeking to make ‘Happy Hour’ last all week.
An emerging trend known as ‘off-peaking’ is leading them to seek to travel more cheaply by avoiding rush hour and to bag food bargains by visiting supermarkets and sandwich shops just before closing time.
As this BBC blog explains: “Off-peaking means doing things when other people are not” – which, of course, has the makings of a basic definition of value investing.
You might even take the analogy further by noting that, just as value investors need to work hard to avoid buying businesses that are cheap for a reason, off-peakers need to be careful to avoid buying cheap food that is well past its sell-by date.
And should any off-peakers be reading this blog – it is, after all, free – then they might be interested in one academic thesis that, here on The Value Perspective, we believe neatly reflects this trend: the Molodovsky effect.
What is the Molodovsky effect?
One of the most common measures of the value of a company’s stock is the Price Earnings (P/E) Ratio. It is the per share price (P) of a company’s stock divided by its earnings per share (EPS).
In his article, “A Theory of Price Earnings Ratios” in the Analyst Journal (1953), Nicholas Molodovsky observed that at the bottom of a business cycle Price Earnings Ratios tend to be high due to lower earnings per share and conversely at the pinnacle of the business cycle they tend to be low due to elevated earnings per share.
This research seems to go against the beliefs of many that growth stocks are associated with high P/E ratios and value stocks with low P/E ratios.
A good illustration of this can be seen in the following chart, which plots the historic EPS and PE/ratios of British Airways over five years.
The blue EPS line fluctuates throughout the business cycle. If the share price of the company remains the same, as earnings drop you would expect the P/E (green line) to increase.
This is because EPS is a denominator of P/E. It's maths.
The fact that the green line follows the blue means that the share price has dropped and that the markets have overreacted to the fall in EPS.
British Airways' EPS and PE ratios over five years
Source: Bloomberg, from June 1999 to December 2004.
We do things a little differently.
By building a picture of a company’s ‘normalised’ earnings and adhering to the belief that, sooner or later, they will revert to the mean, here on The Value Perspective, we can look to take advantage of the Molodovsky effect and use overreactions by the market as an opportunity to ‘off-peak’ our way into good businesses at attractive prices.