Showing posts with label historical PE. Show all posts
Showing posts with label historical PE. Show all posts

Sunday 3 January 2010

Conservative valuation is a crucial part of the investment process.

The key thing to remember for now is simply that if you don't use discipline and conservatism in figuring out the prices you're willing to pay for stocks, you'll regret it eventually.  Valuation is a crucial part of the investment process.

One simple way to get a feel for a stock's valuation is to look at its historical price/earnings ratio (P/E) - a measure of how much you're paying for every dollar of the firm's earnings - over the past 10 years or more.  If a stock is currently selling at a P/E ratio of 30 and its range over the past 10 years has been between 15 and 33, you're obviously buying in at the high end of historical norms.

To justify paying today's price, you have to be plenty confident that the company's outlook is better today than it was over the past 10 years.  Occasionally, this is the case, but most of the time when a company's valuation is significantly higher now than in the past, watch out.  The market is probably overestimating growth prospects, and you'll likely be left with a stock that underperforms the market over the coming years.