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30-08-2023, 07:17 AM
The earnings of companies are never static even if there is no growth. This is because there are socio-economic factors that vary from year to year. Thus, when looking at the earnings power of a company, I normalize the earnings by looking at the performance over the past decade. Hopefully this will take care of the “noise”. Of course, the duration could be shorter depending on the business situation.
Given this “normalization”, the common trailing or even forward PE ratios provided by most platforms are not really useful. If you are going to use the PE you should be looking at normalized PE not only for the target company but also the peers.
These are not straight forward or readily available. That is why I avoid using PE for valuation.
But I must admit that it is a useful screening metric to find undervalued stocks. The question is what is a “cheap” valuation ratio?
The chart below shows the distribution of the PE of the Bursa Malaysia Main Board for 2 different periods. You can see that in both periods, the PE distribution has “fat” tails at both ends. In between the tails, the 2023 distribution is flatter. And the central tendency as measured by the median are different as well
![[Image: Bursa-PE.png]](https://i.postimg.cc/y8Lv0mLv/Bursa-PE.png)
So what is a cheap stock looking at the distribution of the PE? Even if you know the median or mean values, I am not sure whether you can tell looking at the distribution. And we have not even talked about growth yet.
That is why I don’t use the PE for valuation. For screening YES. For valuation NO. If you want to know more about how I value companies go to “Do you really want to master value investing?”
Given this “normalization”, the common trailing or even forward PE ratios provided by most platforms are not really useful. If you are going to use the PE you should be looking at normalized PE not only for the target company but also the peers.
These are not straight forward or readily available. That is why I avoid using PE for valuation.
But I must admit that it is a useful screening metric to find undervalued stocks. The question is what is a “cheap” valuation ratio?
The chart below shows the distribution of the PE of the Bursa Malaysia Main Board for 2 different periods. You can see that in both periods, the PE distribution has “fat” tails at both ends. In between the tails, the 2023 distribution is flatter. And the central tendency as measured by the median are different as well
- In May 2014, the median PE was 11.2
- In Aug 2023, the median PE was 9.0
So what is a cheap stock looking at the distribution of the PE? Even if you know the median or mean values, I am not sure whether you can tell looking at the distribution. And we have not even talked about growth yet.
That is why I don’t use the PE for valuation. For screening YES. For valuation NO. If you want to know more about how I value companies go to “Do you really want to master value investing?”