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Keith Anderson. The Essential P/E
Publishing details
About the Author
Foreword
Preface. Who is this book for?
What does the book cover?
Structure of the book
Acknowledgements
Introduction. Who needs a book on the P/E?
What’s interesting about the P/E?
The faults of the P/E
Putting right the faults in the P/E
PART I. The P/E Calculation
Chapter 1. History of the P/E
The world of investment to 1914: dividend yield is king
The US in the 1920s: enter the P/E
Catching up with the US
The P/E today
Chapter 2. Earnings
From sales to operating profit
Towards the P/E’s earnings figure
EBIT and EBITDA
Basic, diluted and adjusted EPS
Historical, rolling and forecast EPS
Problems with earnings figures
Chapter 3. The Price-Earnings Ratio (P/E)
Understanding the P/E ratio
Figure 1: FTSE 100 P/Es, 1993-2012
Figure 2: Market capitalisations versus P/Es for all UK companies. (7 February 2012)
Historical and prospective P/E
Example. Table 1: Inchcape and Haynes EPSs and P/Es, February 2012
Earnings yield and the E/P
Chapter 4. Practical Calculation of EPS and the P/E from Company Accounts
Profit
Figure 3: Extract of Haynes’ company report – profit and loss account
EPS
Figure 4: Extract of Haynes’ company report – earnings per share
The P/E
PART II. The Value Premium and the P/E
Chapter 5. Value Investing
What is a value share?
Table 2: Ratios for identifying value and glamour shares
The value premium
Table 3: Terminal values of a £250 CTF after 18 years
Table 4: Terminal values of £1,000 invested in a pension fund after 40 years
Value investors
Warren Buffett
Ben Graham
David Dreman
Anthony Bolton
The P/E value premium: early years
Table 5: Seven-year returns grouping by P/E, price-to-sales ratio and price-to-book value, from Nicholson (1968)
Endnote
Chapter 6. Efficient Markets and the CAPM
Efficient markets
Figure 5: Efficient and not-so-efficient markets
The Capital Asset Pricing Model (CAPM)
Arbitrage Pricing Theory (APT)
Reconciling efficient markets and the value premium
Table 6: Annual returns and betas from Basu (1977)
Later years: the P/E sidelined
Endnote
Chapter 7. Accepting Reality: The Fama and French 3-Factor Model
Are SMB and HML grounded in reality?
The F&F model is next to useless for real investors
Lack of a theoretical underpinning
The P/E in the F&F model
Endnote
Chapter 8. Value Investors Fight Back
The P/E effect in the UK
Rehabilitating the P/E
Endnote
PART III. Improving the P/E
Chapter 9. Developing the P/E
The industry-adjusted P/E
The time-relative P/E
The P/E using operating income
Chapter 10. The PEG Ratio
What is the PEG ratio?
Why can’t we predict earnings growth rates?
Figure 6: Subsequent growth after sorting firms into deciles based on prior growth, from Little (1962)
Testing the predictability of earnings in the UK market
Table 7: One-year average returns for stocks with a history of positive earnings, or of positive and growing earnings. All UK stocks, 1975-2004
So what use is the PEG ratio?
Chapter 11. The Long-Term P/E
Haynes’ long-term P/E
Table 8: Haynes Publishing EPS (Source: DataStream)
What use is the long-term P/E?
Table 9: Average one-year returns for decile portfolios of all UK stocks 1975-2009. Companies are sorted into portfolios each year using the traditional P/E ratio (PE1) through to PE10 (the current share price divided by the average annual EPS over the last ten years)
Running high and low P/E portfolios
Figure 7: Portfolio values for the value and glamour deciles using PE1 and PE10 to sort companies into deciles. PE10 is the P/E calculated using average earnings over the last ten years
Chapter 12. Decomposing the P/E
Figure 8: Decomposing the influences on the P/E ratio
The year effect
Figure 9: Market-wide average ten-year P/Es, 1975-2009
The sector effect
The size effect
Figure 10: Average 10-year P/E by market size category, 1975-2009
Constructing the decomposed P/E
Haynes and the decomposed P/E
Testing the decomposed P/E
Table 10: Annual returns by portfolio decile for the traditional P/E, the ten-year P/E and the decomposed P/E, 1975-2009. (The returns shown for the traditional P/E are different to those in Table 9 because we are using only companies with a full ten years of positive earnings here.)
Figure 11: Performances of glamour and value deciles for the traditional P/E, the ten-year P/E and the decomposed P/E
Endnotes
Chapter 13. A Cautionary Tale: The Naked P/E
How many shares should you hold?
Figure 12: Annual returns for value, glamour and arbitrage small portfolios of 5-50 shares, 1975-2009
Figure 13: Average annual returns for very small portfolios of 1-15 shares, 1975-2009
Allowing for risk
Figure 14: Sharpe Ratios of very small value, glamour and arbitrage portfolios of n shares, 1975-2009
A final portfolio example
Figure 15: 1000 invested in the five lowest Naked P/E value shares, the five highest Naked P/E glamour shares, and an equally weighted market average, rebalanced annually, 1975-2009
Tables 11a and 11b: Individual companies and one-year returns for the Naked P/E 5-share value portfolios, 2008-9 and 2009-10
Chapter 14. Have We Rescued the P/E?
PART IV. Beyond the P/E
Chapter 15. Ben Graham: The P/E and the Margin of Safety
Graham’s final formula
Endnote
Chapter 16. Joel Greenblatt: The P/E and Return on Capital
Endnote
Chapter 17. Joseph Piotroski: The P/E and the Fscore
How is the Fscore calculated?
A. Profitability
B. Funding
C. Efficiency
Example: Haynes’ Fscore
(1) Return on Assets (ROA)
(2) Change in ROA
(3) Cash flow from operating activities
(4) Quality of earnings (accruals)
(5) Change in gearing (leverage)
(6) Change in liquidity
(7) Change in shares in issue
(8) Change in gross margin
(9) Change in asset turnover
How well can the Fscore predict returns?
The Fscore in the UK
The Fscore and price-to-tangible book value
Table 12: Returns for high, medium and low price-to-book value groups within Fscores, 1995-2010
The Fscore and the P/E
Table 13: Returns for high, medium and low traditional P/E groups within Fscores, all companies with ten or more years of positive earnings, 1995-2010
Table 14: Returns for high, medium and low ten-year P/E groups within Fscores, all companies with ten or more years of positive earnings, 1995-2010
Table 15: Returns for high, medium and low decomposed P/E groups within Fscores, all companies with ten or more years of positive earnings, 1995-2010
Figure 16: Combining the Naked P/E with Fscores. All UK companies 1975-2010 (Fscore from 1995)
Going beyond the P/E
Conclusion
Appendix: FTSE 100 EPSs and P/Es
Glossary
References
