Educational Programming Video
The Value Line Investment Survey
Program 9: Relative Price/Earnings Ratios
In this session we will continue an ongoing discussion on Price/Earnings Ratios. In the first session on P/E Ratios, we discussed the Value Line P/E Ratio that appears at the top of every company page in The Value Line Investment Survey. In the second session, we discussed Trailing P/E Ratios and Median P/E Ratios, two other statistics that appear at the top of every page. In this session we will discuss the Relative Price/Earnings Ratio, the fourth P/E statistic that appears at the top of each page.
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 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. I will talk more about "normalized" earnings in a future session, but the subject is a very important one since so many companies have had very large "one-time" writeoffs in recent years.
The Relative Price/Earnings Ratio compares the Price/Earnings Ratio of one company with the Median Price/Earnings Ratio of all the stocks with earnings reviewed in The Value Line Investment Survey. The Median Price/Earnings Ratio of all stocks, by the way, is shown every week on the cover of the Summary & Index (in a box half way down the page on the left). Very simply, if the Relative P/E Ratio of a stock is more than 1, that stock's P/E is higher than that of the Value Line universe; if the Relative P/E is less than 1, the stock's P/E is less than that of the Value Line universe.
If one stock's P/E is much higher or lower than the average, there is probably a reason for it, and if you are interested in such a stock, you should try to find out what the reason is. Generally speaking, stocks with high Relative P/Es have above-average sales and earnings growth characteristics; that is, the companies have probably been growing faster than most other companies and will probably continue to grow more rapidly. But there may also be other reasons. If a stock has a high Relative P/E and you own it or are thinking about buying, you definitely want to make sure that sales are earnings are likely to grow in the years ahead. Stocks with low Relative P/Es tend to have below-average sales and earnings growth characteristics. They are often stocks of companies without much growth potential.
You should be aware that many stocks regularly have high or low Relative Price/Earnings Ratios, and it may be unrealistic to think that they will change. Computer Software companies, for example, frequently have high Relative P/Es; Steel companies almost always have low relative P/Es.
You can see the history of a stock's Relative P/E by looking in the statistical section, which we call the statistical array, in the center of each Value Line report. In the ninth row from the top you will normally find the (average annual) Relative P/E Ratio.
By examining the annual Relative P/E Ratios that a stock has sold at in the past, you can quickly see if a stock has typically sold at a high Relative P/E, a low Relative P/E, or somewhere in between. If a stock has a currently high Relative P/E, but has most often had a high Relative P/E in the past, everything may be fine. You may have no cause for concern. On the other hand, if a stock has a currently high Relative P/E but it has not usually had a high Relative P/E in the past, you may have some concern. You will certainly want to assure yourself that there are good reasons why the stock's Relative P/E has increased recently by doing more research. Concerns about a low Relative P/E would generally be just the opposite of those for a high Relative P/E.
I've spent a lot of time speaking about P/E Ratios, but the subject is an important one. In the next session, I will move to a new topic that will hopefully make you better understand the information in The Value Line Investment Survey and make you a better investor.
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