The Folly of P/E Multiples

I saw an article in the Financial Post called "The Folly of P/E Multiples". This article talks about not just looking at P/E Ratios to determine how reasonable a stock price is. The article talks about 5 stocks with high P/E Ratios that the author thinks investors should look further into than just P/E Ratios.

I must admit that P/E Ratios are one measurement that I use. However, I also like to look at, at least 3 other measurements to decide how reasonable a stock is priced. The stock price tests that I generally do are a P/E Ratio test, Price/Graham Price Ratio test, Price/Book Value per Share test and a dividend yield test.

With the Price/EPS Ratio test that I do, I like to compare the current P/E Ratio using this year's EPS estimates and the current price against the 5 year low, median and high median P/E Ratios. There are some rules of thumb with P/E Ratios, with below 10.00 being cheap and above 30.00 being expensive. However, you have to be aware that different sectors have different P/E Ratios that are considered low and high. Also, growth stocks tend to have quite high P/E Ratios.

My Price/Graham Price Test is a comparison of the current P/GP Ratio with the 10 year low, median and high median P/GP Ratios. Generally speaking, a P/GP Ratio of 1.00 or lower is pointing to a cheap stock. However, here again what ratio is considered cheap can vary by stocks in different sector.

For the Price/Book Value per Share Ratios stock test, I compare the current P/BV Ratio to the 10 year close median P/BV Ratio. Generally speaking, if the current P/BV Ratio is 80% of the 10 year close median P/BV Ratio, the stock is considered to be cheap. If the current P/BV Ratio is close to the 10 year close median P/BV Ratio, then the stock price is reasonable.

There is also some rule of thumb values such as if the current P/BV Ratio is 1.00 or lower, a stock is considered cheap and if the current P/BV Ratio is 1.50 then the stock price is considered reasonable. However, the P/BV Ratio can also vary by stock sector.

The last test I generally do is comparing the current dividend yield to the 5 year median dividend yield. Basically you want the current yield to higher than 5 year median dividend yield. (Here the higher the dividends yield the better the stock price.) If the current dividend yield is 20% higher than the 5 year median dividend yield, the stock price is considered to be cheap. A stock price is considered reasonable, if the dividend yield is close to the 5 year median dividend yield and a stock price is considered high if the current dividend yield is 20% lower than the 5 year median dividend yield.

I have recently been looking at historical high, low and average dividend yields as a comparison to the current dividend yield. I wrote about this in two recent posts of Dividend Growth Dividend Growth Updated .

On my other blog I am today writing about Keg Royalties Income Fund (TSX-KEG.UN, OTC-KRIUF)...continue...

This blog is meant for educational purposes only, and is not to provide investment advice. Before making any investment decision, you should always do your own research or consult an investment professional. See my site for an index to these blog entries and for stocks followed. Follow me on Twitter.