What is P/E Ratio? [and Why it SUCKS!] | Summary and Q&A

TL;DR

The PE ratio is a misleading measure of a stock's value, often leading investors to make poor decisions. Three alternatives, including price-to-sales, price-to-book, and price-to-cash flows ratios, offer more accurate assessments.

Key Insights

• 🥳 The PE ratio is often misleading, as it oversimplifies stock valuation and fails to consider accounting tricks employed by companies.
• 🥳 Comparing PE ratios requires considering a stock's historical average and similar companies within the same industry.
• 🥳 Alternative measures like price-to-sales, price-to-book, and price-to-cash flows ratios offer more accurate assessments of a stock's value.
• 🥳 The price-to-sales ratio considers a company's revenue, price-to-book ratio focuses on assets and debts, while the price-to-cash flows ratio examines the cash flow from operations.
• 🍝 Proper stock valuation requires a comprehensive analysis that combines multiple measures and takes into account a stock's past performance and future prospects.
• 🪛 Investors should be cautious of the entertainment-driven nature of investing, as excessive trading benefits brokers and not necessarily the investors.

Transcript

What is the PE ratio and how does it lose investors money? Why is the most popular measure in stock investing almost completely useless? Beat debt. Make money. Make your money work for you. Creating the financial future you deserve. Let's Talk Money. In this video, I’ll show you why the PE ratio is a sewer of information, how company management tri... Read More

Questions & Answers

Q: What is the PE ratio, and why is it considered almost worthless?

The PE ratio is a measure of a stock's value calculated by dividing its price by its earnings. However, it fails to consider a company's accounting tricks and oversimplifies the complex dynamics of stock valuation.

Q: What is the difference between trailing and forward PE ratios?

The trailing PE ratio uses the company's past year's earnings, while the forward PE ratio relies on projected earnings for the upcoming year. Forward PE ratios are often lower due to higher expectations for future profits.

Q: Why is it essential to compare PE ratios within the same sector and industry?

Different sectors have varying earnings growth rates, making a direct comparison between unrelated industries misleading. Comparing PE ratios within the same sector ensures a more accurate assessment.

Q: How does the price-to-sales ratio provide a cleaner evaluation of a company's value?

Unlike the income statement used for calculating the PE ratio, the company's revenue reported on the top line is less susceptible to manipulation, making the price-to-sales ratio a more reliable measure.

Summary & Key Takeaways

• The PE ratio, while widely used, is an oversimplified and misleading measure that lures investors into thinking they know a stock's true value.

• Three alternative ratios, including price-to-sales, price-to-book, and price-to-cash flows, provide more reliable assessments of a stock's value.

• Comparing a stock's value against its own historical average and similar companies in the industry is crucial to understanding its investment potential.