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Interpretation of the PE
ОглавлениеAs mentioned above, the PE is a measure of the value placed on a company by the market. If investors like a company they will buy the shares, which will drive the share price up, which will result in a higher PE. This is a simple function of the calculation of the PE. Remember, the formula is:
PE ratio = share price/earnings per share
If the earnings per share stay the same but the share price increases, this results in a higher calculated PE.
Conversely, if investors dislike a company they will sell the shares, which will drive the share price down, which will result in a lower PE.
Companies with high PEs are often referred to as being highly rated by the market, while companies with low PEs are often referred to as being lowly rated by the market.
But the big question is: what level is considered high (or low) for a PE? For example, is a PE of 20x considered high?
There is no short answer to that question. Different people interpret the PE differently.
For example, growth investors may regard a PE of 30x as not unreasonable if a company is expected to grow strongly. Whereas a value investor (like Warren Buffett) prefer companies with low PEs. It is not surprising that Buffett never invests in technology companies (that often have high PEs).
Personally, I align myself with Buffett and prefers companies with low PEs. A low PE shows that the stock is cheap relative to its earnings. We know that price and earnings are inextricably linked, which makes the low PE stock a safer proposition with a lower downside risk.