It is not possible to rely on a simple comparison between price-earnings ratios, PERs. Consider two companies, firm A and firm B. Both companies’ earnings have been the same in recent years, and they are expected to double over the next four years. The PER of both companies is 20.
Similar companies in the same industry, but with no prospect of growth in earnings, are selling at ten times earnings.
Move on four years, and assume that investors still value shares with no growth prospect at a PER of ten.
Company A is expecting earnings to double over the subsequent four years as they did over the previous four years, so it will still be selling at a PER of 20 and its share price has doubled.
Company B on the other hand does not have any future growth potential, so it is now valued at ten times earnings because it is a no-growth company.
Despite its earnings doubling over the previous four years, its share price remains the same.
Investors must be prepared to pay a high PER for shares when confident that earnings will continue to grow over many years.
If a company has a proven policy of developing new sources of earning power, and if the industry it is in is one which is likely to continue to show substantial surges of growth, then its PER ratio in five or ten years time is likely to be as high compared to the average stock as it is now.
It is often the case that sha.....To read more subscribe to my premium newsletter Deep Value Shares – click here http://newsletters.advfn.com/deepvalueshares/subscribe-1
I'm a full-time investor running my portfolio. I invest other people's money into the same shares I hold under the Managed Portfolio Service at Henry Spain. Each of my client's individual accounts is invested in roughly the same proportions as my "Model Portfolio" for which we charge 1.2% + VAT per year. If you would like to join us contact Jackie.Tran@henryspain.co.uk
investing is about making the right decisions, not many decisions.