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Posted on 14 April 2011 | 5,546 views

The Nifty-Fifty High Price to Earnings Ratio and Subsequent Crash

The original Nifty-Fifty was a list of stocks during the 60s and 70s which had solid earnings growth and high price to earnings ratio in which the prices of those growth stocks rose to unreasonable heights in the early 1970s, as evidenced by their subsequent crash.

The majority of the Nifty-Fifty on the list had price to earnings ratio of 50 or more which is why they were also named “50” — these stocks lost their luster during the bear market of 1973-1974, where these stocks were crushed in a matter of months.

Many large institutions recommended these Nifty-Fifty stocks to their clients as life long buy and holds — those fifty stocks where all large caps on the New York Stock Exchange. The 1973-1974 Bear Market, which brought a sharp decline on these companies changed the views of institutions on these stocks overnight, and the “Nifty 50” was all but forgotten. It wasn’t until after the 1987 crash through the late 1990s did investors once again buy these stocks for longer term investments and not for quick swing gains.

The Nifty-Fifty story is that investors became too fascinated with growth stocks in the early 1970s and pushed the prices of their favorites to unjustified heights. At the time, the long-run performance of these investor favorites justified their seemingly high prices and there is a substantial and statistically persuasive inverse relationship between P/E ratio and subsequent long-term performance.

People often recall the early 1970s when institutional investors were infatuated by the Nifty Fifty — a small group of “One-Decision Stocks” — companies so appealing that their stocks should always be bought and never sold, regardless of price. Among these select few were Avon, Disney, McDonald’s, Polaroid, and Xerox. Each was a leader in its field with a strong balance sheet, high profit rates, and double-digit growth rates.

The “Nifty Fifty” stocks rose to very high levels in the 1960s, but was followed by very flat stock market prices for two decades. At some price, a great company’s stock is expensive and at some price, a lousy company’s stock is cheap.

The original Nifty 50 list of stocks …

American Express

American Home Products

AMP Inc.

Anheuser-Busch

Avon Products

Baxter International

Black & Decker

Bristol-Myers

Burroughs Corporation

American Hospital Supply Corp.

Chesebrough-Ponds

The Coca-Cola Company

Digital Equipment Corporation

Dow Chemical

Eastman Kodak

Eli Lilly and Company

Emery Air Freight

First National City Bank

General Electric

Gillette

Halliburton

Heublein Brewing Company

IBM

International Flavors and Fragrances

International Telephone and Telegraph

J.C. Penney

Johnson & Johnson

Louisiana Land and Exploration

Lubrizol

Minnesota Mining and Manufacturing (3M)

McDonald’s

Merck & Co.

MGIC Investment Corporation

PepsiCo

Pfizer

Philip Morris Cos.

Polaroid

Procter & Gamble

Revlon

Schering Plough

Joe Schlitz Brewing

Schlumberger

Sears, Roebuck and Company

Simplicity Patterns

Squibb

S.S. Kresge

Texas Instruments

Upjohn

The Walt Disney Company

Xerox

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