Understanding P/E

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P/E remains one of the most used metrics to value stocks. It is very easy to compute. But it’s not always easy to interpret. « Most investors fail to have a clear sense of what a particular multiple implies about a company’s future financial performance and don’t understand how multiples change over time », according to Michael Mauboussin and Dan Callahan in a report published in 2014 by Credit Suisse (this article is mainly based on their note which you can read here).

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Review the Basics: Thoughts on Valuation (1997) – Mauboussin

Michael Mauboussin is a highly respected investor, teacher, speaker and book writer. I came across a number of his notes in the past (including this one which I liked a lot). Thanks to the Internet and the many people who share good thinking, most of his notes are there to grasp and read.

While re-populating my blog, I came into his 1997 reflections on valuation. As Graham/Buffett nicely put it: price is what you paid, value is what you get. So to earn decent return when investing, you need to know the value so you can pay a price that gives you a good margin of safety.

The full note is available to read here. I just wrote down a couple of remarks that make sense to me and hopefully give you a quick overview of why it might be useful and what you will find inside.

Key purpose of the note is to defend the value-based approach of investing,  to keep in mind what really matters in valuation and not to fall into « market myths ».

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