P/E Ratios

TakeCareOfThePennies_2

Perusing this forum of late, it has come to my attention that little old P/E ratio is being abused ....

If company A shares are valued on a higher P/E ratio than company B then it suggests that investors have more confidence in the management of company A to profitably grow their business in the future.

The dude I just watched being interviewed about it was banging on about PE ratios on Iranian companies and how good they are.

You need to remember that P/E ratios are inextricably linked to fundamendals. Blindly comparing P/E ratios across countries or between companies is not going to be of much use.

For example, how are you dealing with outliers ? High P/Es or negative earnings ? How about the other factors you need to consider with P/E ratios, have you considered them ?

A lot of good stuff on this subject has been written by Aswath Damodaran in his book Damodaran on Valuation. He is Professor of Finance at NYU, so he knows his stuff.

He hints at some of it on his blog (http://aswathdamodaran.blogspot.co.uk/2013/07/market-multiples-global-comparison-and.html)

I'm not going to repeat what he says, if you're serious about investment based on fundamental parameters then you need to read his books. Its not an easy read, so only for those who are genuinely serious.

If you don't want to buy books, then do some more "desktop research" on the internet and find similar content written by other people that tells you how to properly use P/E ratios.

P/E is only a minor part of the fundamental valuation process. There's other stuff out there that's more important (e.g. DCF, SOTP NAV etc.). But they are more important because they take more skill to calculate and have a lot of scope for subjective fine-tuning based on your preferences or that of the analyst. You really don't want to be overly reliant on simple multipliers like P/E,P/B etc. They are not magic bullets.