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.

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The Intelligent Investor

This book will not teach you how to beat the market. However, it will teach you how to reduce risk, protect your capital from loss and reliably genera...

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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.

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The method of calculating Price/Earnings ratio presented in The Intelligent Investor challenges existing practices by insisting on calculating the P/E ratio based on a multi-year average of past returns, rather than primarily on next year's earnings as is commonly done on Wall Street. This approach reduces the likelihood of overvaluing a company due to an unusually profitable year or high revenue projections. For example, if a company has earned $0.50 per share over six years but earned $3 over the last 12 months, using the traditional method, the stock would be valued 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.

The Price/Earnings (P/E) ratio is a financial metric used to evaluate the valuation of a company. It's calculated by dividing the market value per share by the earnings per share (EPS). In The Intelligent Investor, Graham suggests calculating the P/E ratio based on a multi-year average of past returns, rather than just the next year's projected earnings. This approach reduces the risk of overvaluing a company due to an unusually profitable year or optimistic revenue projections. For example, 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 the P/E ratio is calculated based on the average earnings over the past seven years, the stock would be valued at just $21.43 (also at 25 times the P/E ratio). This method provides a more conservative and potentially more accurate valuation.

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