Educational Programming Video
The Value Line Investment Survey
Program 8: Trailing/Median Price/Earnings Ratios
In this lesson, we're going to continue our discussion of Price/Earnings Ratios. In the last session, we discussed the basic information about the P/E Ratio shown at the top of each Value Line page. We will now focus on Trailing and Median P/Es.
To briefly review, all P/E Ratios are calculated by dividing the price of a stock by 12 months of earnings per share of the same stock. The price used in the calculation is almost always the most recent one, but depending on the source, the 12 months of earnings can differ, sometimes substantially.
The P/E Ratio at the top of the Value Line page is calculated by dividing the recent price of the stock by the most recent six months earnings per share plus the projected earnings per share for the coming six months. The Value Line calculation is a somewhat unique one, in that it partly uses actually reported historical earnings and partly uses projected earnings. It is also unique because the earnings Value Line reports for companies are "normalized," that is, they exclude non-recurring, one-time gains and losses. Value Line has long excluded unusual windfalls or charges from company earnings, and we believe that by doing so, we present an earnings picture that is most useful for an investor. We will further discuss "normalized" earnings in a future session.
Now for the Trailing Price/Earnings Ratio. On the top of each Value Line page, we show a Trailing P/E. This Trailing P/E is calculated by dividing the recent stock price of a stock by the last 12 months of reported earnings per share. There are no earnings estimates involved, just actually reported earnings per share for the past 12 months. The Trailing P/E is the P/E Ratio shown in most newspapers, including The Wall Street Journal and The New York Times. It is also in Barron's.
The Trailing P/E Ratio is widely used because trailing historical earnings are the only earnings the newspapers have. Unlike Value Line or the larger securities brokerage firms, they don't have analysts, and they don't try to estimate earnings. They also don't have analysts or statisticians to determine which items in a company's income statement are unusual, or one-time, and should be excluded. They simply gather earnings reports as companies issue them, and then calculate a company's past 12 month's earnings.
Because of the different methods of calculation, the P/E shown in Value Line may differ considerably from the one shown in the newspaper. That will be particularly true if the Value Line earnings figure excluded unusual, large one-time gains or losses. It is also true if a company's earnings are expected to rise or fall considerably in the next six months. In the latter case, the Value Line P/E would reflect the expected rise or fall in earnings, while the newspaper's P/E wouldn't.
Which is better? Value Line's P/E or the newspaper's P/E. We think our P/E is because it does include an earnings forecast, and we suggest you use it. But the important thing is that when you are comparing the P/E of one stock with the P/E of another stock, you use the same source. Compare the P/E of one stock in Value Line with the P/E of another stock in Value Line. Compare the P/E of one stock in a newspaper with the P/E of another stock in the same newspaper. Don't compare the Value Line P/E with the newspaper's P/E; they will often not be comparable.
Now for the Median P/E, which is also shown at the very top of the Value Line page. The Median P/E is a rounded average of the middle values of a range of the annual price/earnings ratios over the past ten years. The statistic is designed to give investors an easy-to-understand "typical" P/E of a stock over the past 10 years. By comparing the current P/E Ratio with the Median P/E, the investor can quickly see how the current P/E compares with the stock's historical P/E and can tell if the current P/E is higher, lower, or about the same as the average P/E in the past. Investors often look at these two P/Es to try to determine if a stock is currently overpriced or underpriced on an historical basis.
We do offer a word of caution, however, about placing too much emphasis on the Median P/E. The booming stock market in the past decade has increased the P/Es of many stocks, often to levels well above anything ever seen in the past. This is particularly true of many of the largest capitalization stocks (General Electric being a good example) as well as of those associated with new technology and communications businesses. It is quite possible that the P/Es of some of these stocks will remain at historically high levels and not retreat to the historical norm.
Whether a stock's P/E will move up or down is something that you will have to decide for yourself. However, Value Line does provide guidance by providing our analyst's P/E forecast in the far right column of the Statistical Array in the center of each report.
We have a lot more to discuss about Price/Earnings Ratios. We hope you learned something today. In the next session, we will discuss Relative P/E Ratios.
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