Question
The Price/Earnings (P/E) ratio is a valuation ratio of a company's current share price compared to its per-share earnings. In 'The Intelligent Investor', it's suggested to calculate the P/E ratio based on a multi-year average of past returns. This approach reduces the risk of overvaluing a company due to an unusually profitable year or optimistic revenue projections. For instance, if a company has earned $0.50 per share over six years but earned $3 over the last 12 months, the P/E ratio based on the last year would value the stock at $75 (at 25 times the P/E ratio). However, if valued at 25 times the average earnings over the past seven years, the stock would be valued at just $21.43. This method provides a more conservative and potentially more accurate valuation.
This question was asked on:
Wall Street calculates the Price/Earnings ratio primarily on next year's earnings. However, Graham insists on calculating the Price/Earnings Ratio based on a multi-year average of past returns, which lowers the odds that an investor will overvalue the company simply because it had an odd profitable year or has high revenue projections. Let's say a company has earned $0.50 per share over six years but earned $3 over the last 12 months. At 25 times the P/E ratio (based on the last year), the stock would be valued at $75. In contrast, valued at 25 times the average earnings over the past seven years, and the stock would be valued at just $21.43.
Receive new free presentations every Monday to your inbox.
Full content, complete versions — No credit card required.
