WWII 028: Price to Earnings Ratio And How To Intepret It, Investing in Foreign Sovereign Bonds, Buying Stocks Directly, Retailer Hacked
In this episode, I shine the light on the Price to Earnings Ratio and how to use and interpret it in your investing activities.
· Ratio used to indicate valuation as a multiple of earnings per share
· Numerator is the current stock price, on a per share basis
· Denominator is the earnings per share of the organization on 4 quarter or annual basis
· The standard P/E looks backward
· The forward P/E is the P/E at the current stock price and estimated forward 4 quarters of earnings.
· Breakdown what the multiple means
o A low P/E could be a function of either an increasing earnings with a low stock price, or expectations of lower future earnings
o A Low P/E could be an indiciation of individual or industry wide problems
o A high P/E could mean has depressed earnings,
· One time charges can impact the P/E and should be backed out.
· Some companies report adjusted earnings in an attempt to be comparable to normal periods
· Low P/E could be a value, and low expectations for future earnings
· A High P/E may indicate future growth is priced in.
· A High P/E could be the market indicating a future return to a normalized valuation after depressed earnings.
· A High P/E could result from charges as well.
· Generally, a P/E of 10 or less (paying 10 years worth of current earnings) means cheap if everything else is normal
· A High P/E of 20 or more could indicate a market-favored business.
· Compare average P/E over last ten years with the current P/E to see if there is a change in market expectations.
Common yardsticks such as dividend yield, the ratio of price to earnings or to book value, and even growth rates have nothing to do with valuation except to the extent they provide clues to the amount and timing of cash flows into and from the business."
Berskshire Hathaway 2000 Annual Letter to Shareholders
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