And You Thought You Knew The P/E Ratio
Posted on May 27, 2008 in the Investing category
.The Price –Earnings (P/E) ratio is one of the most common measurements investors use to measure the performance of individual stocks or the overall stock market.
The traditional PE ratio is calculated as:
For example, if stock A is trading at $24 and the earnings per share for the most recent 12 month period is $3, then stock A has a P/E ratio of 24/3 or 8.
But today, bulls and bears calculate earnings a little differently. Bulls use what is called operating earnings (operating earnings exclude write-offs) and also use the forward projections of earnings for the next 12 months. Forward or projected earnings are typically higher than trailing earnings.
Bears use what is called reported earnings (which include write-offs) and also use the earnings for the trailing 12 months.
Does it make a difference? Well reported earnings for the S&P 500 for 2007, were just over $66. The operating earnings for 2007 were $84.54. The estimated numbers for 2008 are about $69 for reported earnings and $89.44 for operating earnings.
So bulls can say that the S&P 500 trades at 16 times 2008 earnings of $89.44 and 13 times the 2009 estimate of $110.44. Bears however say that the S&P 500 is trading at 24 times trailing earnings and about 21 times the estimated 2008 reported earnings. That is a huge difference between the two.
So the next time you hear an someone talking to you about how cheap (or expensive) the S&P 500 P/E ration is, ask them whether they are talking about reported or operating earnings.
To paraphrase a car commercial, today’s price-earnings ratio is not your father’s price-earnings ratio.
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