Watch PE when valuing a company

[ashparagon]

Tip for you, P/E is a useless ratio for a value investor.

I have to disagree though... P/E is overrated but I don't think it's useless. It has its limitations, e.g. not applicable to certain industries with uneven earnings like construction/property/REIT etc, and works differently for cyclical industries; as Peter Lynch puts it, low P/E may signal its peak and high P/E the trough.

Apart from that, P/E is a good gauge if you know how to utilise it. It depends on what context you use it for. As what Warren buffet mentioned, 'Price is what you pay and value is what you get.' And what are the valuable factors in a company? Earnings, assets, cash flow, growth, you name it. So how can you determine a company is undervalue? Using valuation methods such as P/E, PEG, Price to Book Value, DCF, RNAV, etc.

How else would you determine the price to value of the company as a value investor?

[yawnyawn]

I use PEG for growth stocks. But PEG not useful if the stock in question is in a cyclical industry. eg airline, automobile industry

[CityFarmer]

I merged the thread "The P/E ratio is twaddle" into this thread, since both are talking on the same topic.

Thanks

Regards
Moderator

[arriyana]

I personally love PE ratio simply because it has a basic rationale behind it. A 10x ratio means you take 10 years to earn back your capital assuming earnings stay constant for the next 10 years. The problem with PE ratio is people get obsessed with it. In a cyclical industry, it is only rationale for you to moderate it to reflect its true value. Blaming an indicator for being inaccurate is like blaming the pen for poor handwriting.

[Behappyalways]

Just for fun sake......is the company below an attractive buy using PE and P/NTA

http://infopub.sgx.com/FileOpen/Swing_In...eID=264441

next look at this- see post 7...is the same company an economically viable company
http://valuebuddies.com/thread-3268-post...l#pid74506

food for thoughts ^^

[BlueKelah]

Just for fun sake......is the company below an attractive buy using PE and P/NTA

http://infopub.sgx.com/FileOpen/Swing_In...eID=264441

next look at this- see post 7...is the same company an economically viable company
http://valuebuddies.com/thread-3268-post...l#pid74506

food for thoughts ^^

Definitely looks undervalued by above two measures and business is stable, but currently is in quite a bit of NET DEBT + Many Rights Issue. I would say good to put on watch list over next couple years to see how management address the debt issue.

[Behappyalways]

without the 'yearly' cash injection, the company might have problem operating as an on going concern.

It looks like a ......scheme where ........... investment operation that pays returns to its investors from existing capital or new capital paid by new investors, rather than from profit earned by the individual or organization running the operation

so the PE and P/NTA is kinda useless or faulty in this case.....

[CityFarmer]

I personally love PE ratio simply because it has a basic rationale behind it. A 10x ratio means you take 10 years to earn back your capital assuming earnings stay constant for the next 10 years. The problem with PE ratio is people get obsessed with it. In a cyclical industry, it is only rationale for you to moderate it to reflect its true value. Blaming an indicator for being inaccurate is like blaming the pen for poor handwriting.

PE ratio is a tool. We might blame it inaccurate because the "PE" is directly from the AR.

I always prefer adjusted PE, from the reported PE. I will adjust it to exclude one-time items, fair values etc, and focus on recurring items. That make the adjusted PE more meaningful, and useful during the DD of a counter.

[specuvestor]

Yes. The video is talking about something else though. It pays to watch if you haven't.

That guy in the video said if 2 companies have the same PE at 10, ROE at 20%, share price at $2, in fact everything the same, except that company A pays all the profits in dividends while company B don’t pay any dividend, which company gives you more in 5 years time? The answer is company B. Because company B gives you 20% return of your money while company A only gives you only 10%.

My question is how is that company B gives you 20% return 5 years later?

This example requires the assumption that the business is scalable and that earnings growth is roughly going to be roe x (1-payout ratio). In this case, growth will be 0 for company A and 20% for company B.

Assuming you buy 1000 shares,

The company that does not reinvest it's profits is assumed to have 0 growth and therefore will earn $0.2 per share for perpetuity. Assuming you reinvest all dividends at 10x PE, after 5 years, you will have $3220 (1610 shares at $2 a piece, 10 x PE)

The company that reinvests will earn 0.2(1.2)^t per share, where t is the number of years from now. Now after 5 years, the company is now earning $0.5 per share and applying a 10 x PE, price is now almost $5, effectively compounding your investment at 20%.

Just want to add to this discussion and calculation. Clement is right on a financial 101 basis, but the way value investors and businessman looks at it is a bit different.

In the case of dividend paying, assuming no reinvest, the guy now has $1 in cash and $2 market value in shares.

With no dividend paying the guy owns say $5 in market value

What is the ROIC for the guy at 5th year going forward? With paid dividends, his effective Invested Capital is $2-$1=$1. With just $0.2 dividend his ROIC on 6th year is going to be 20% and 7th year is 0.2/(1-0.2)= 25%

For the no dividend case, his Invested Capital is still $2. Over the long run, it is hard for it to beat the ROIC of a dividend paying company since on the 10th year the Invested Capital is zero ie fully paid back. As in all exponential curve, you will not see the difference in first 5 years and note some difference in 10 years, but big difference thereafter.

And we haven't factor in counterparty risk ie the investor face the full risk of the non dividend paying company throughout the years. Only way to remove the counterparty risk is to sell the stock.

This is one of the most important lessons on Buffett.

Back to PE... forumers know I am skeptical on PE. It is a good screening tool, but it remains at best as that. Value investors look at cashflow return on unleveraged equity.

Tip for you, P/E is a useless ratio for a value investor.

I have to disagree though... P/E is overrated but I don't think it's useless. It has its limitations, e.g. not applicable to certain industries with uneven earnings like construction/property/REIT etc, and works differently for cyclical industries; as Peter Lynch puts it, low P/E may signal its peak and high P/E the trough.

Apart from that, P/E is a good gauge if you know how to utilise it. It depends on what context you use it for. As what Warren buffet mentioned, 'Price is what you pay and value is what you get.' And what are the valuable factors in a company? Earnings, assets, cash flow, growth, you name it. So how can you determine a company is undervalue? Using valuation methods such as P/E, PEG, Price to Book Value, DCF, RNAV, etc.

How else would you determine the price to value of the company as a value investor?

[freedom]

PE is a great tool of investment. And there is no perfect tool for anything. People don't blame the tool when it fails. People blame the one who uses the tools.

The same can be said about PE. It's a great way to look at investment. But any great tool in incompetent hands is useless.