The Value Investor v.02 The dangerous PE’s



Part 1 – High PE-numbers (part 2 will be published 19/1)

Among the first things an investor learns is PE’s. The classic equation, in which the parts share price (P) with last year’s (or estimated next year’s earnings (E), and will arrive at a simple figure. A high figure is as everyone knows is a sign of a high score and vice versa.

Simple metrics are often good indicators because they provide a lot of information and takes up little memory space in the brain, which is handy when there is so much else to keep track of the different companies you are interested in. However, there are lots of dangers also in this strong faith in the handy PE’s as I see it.

PE’s can be seen everywhere and the perception of many investors, especially those who are not so experienced, is that high PE means that the company is ”expensive”, which of course is bad. You usually hear that they have a ”stretched valuation” and would be a more risky investment than a company with low PE. For the latter, the companies spoken often about how ”cheap” they are, their valuation is ”attractive” and the risk is claimed that is said to be lower.

Sure, I’m generalising now but pretty much runs the talking so, not least when the course suddenly risen or fallen for a certain share. However, this is also the dangerous. To believe that a share is by definition ”high risk” for PE is high and low risk for PE is low is crazy. It is a bit like the nutrients – it’s true that we need salt in your diet to feel good but we feel better if we pour a lot of salt, on the contrary, actually. If you want to be really generalizing one can say that good companies have high PE, and bad companies have low PE.

A high PE is a sign that the market believes in a company’s prospects and a low PE means the opposite. The danger lurks, therefore, not directly in the PE’s, but the market’s faith. PE is just a bit of a blunt way to measure this. If a highly valued companies continue to meet market expectations, so will the PE’s are likely to be unchanged (and vice-versa if you can’t handle this). This means that the price will rise about as much as the gain increases.

The latter is extremely important to understand and it is clear to me that many do not. High PE means not that a share is ”fullvärderad” and it takes a miracle for it to rise. If a companies t.ex. profits increase by 40-50 % per year and has a PE of 50, so will the PE are not likely to fall or in any case did not fall significantly so long as it continues to deliver, and prospects are unchanged good. Then rises the price per share probably at about the same rate.

That PE remains high does not mean, as you sometimes hear, that the market go crazy and think that the current growth will remain for always, but just that the market is very positive to the company’s prospects. It allows even the common expression ”They must now grow into the valuation” is quite misleading. There is no law of nature that says that it is only possible to increase the gain a certain number of years, although it is common to vinstökningstaken declines with time. Profits can’t rise too much but you should, as I wrote in a column recently, do not assume that the profit increase is slowing too quickly. You should not think that the growth-oriented investment does not go well with värdeinvestering. I also have written in the past, the growth is a great value for a company. Värdeinvestering is thus not to buy ”boring” companies.

For good just a year ago I bought Netflix (see previous post), a company with both the rapid increase of the turnover and especially profit, albeit from a rather low level in terms of profits, but also very high expectations from the market and therefore high PE (over 300). Many have, through the years warned of this company just based on the high PE’s but less often to think that something specific to hit them and make the prospects to be obscured. Often do you make assumptions about what development is implied in the valuation, t.ex. this also warns of Amazon and this one, both from 2013… the Problem with these calculations is generally not highly valued companies will be köpvärda. Set up an equation, in which t.ex. requires a 10 % return and count on an already high PE, so it will be up to it ”required” a jättetillväxt in lots of years to ”justify” the course. Netflix has femtiodubblats during the time that the company has been ”highly” valued, and even if it is an extreme example, this happens everywhere.

During the first nine months of the year increased Netflix turnover by 33 %, and thanks to the fine scale gain of 233 %. With Netflix earnings were low in relation to sales when you bet on such rapid expansion was the PE also puffed up and fell a part but its shares rose as seemingly substantial and for those who just as I thought that Netflix would continue to deliver it was reasonable to buy the stock and keep it. It would, of course, could go bad, but it is not unreasonable to believe that a very successful business to continue to reap the successes (and vice versa). PE today at the latest 12 months ‘ earnings is more than 200.

Of course, there are lots of examples of companies with high PE as it falls like a stone when expectations are missed, t.ex. the two companies I usually complain about (H&M and FING). These have been passed down for a longer period of time but typically is also that companies with high PE fall sharply in the single rapportmissar, this has happened to Netflix many times. However, there are also plenty of examples of companies that are highly rated but will be great investment. Not just a few percent above the index without investment that changes the lives of the owners. Amazon has the t.ex. always been sky-high-valued, not rarely with PE over 500, but also delivered thousands of percent rise, to the shareholders, the same with H&M during the good years, PE were often over 30 but share good and step as long as the expectations were met. My other favorites, t.ex. Evolution Old-timer (43), LeoVegas (34) and LVMH (31) are also good examples of companies with clearly higher PE than the rest of the stock market, but whose share is rising steadily, as turnover and profits continue to increase.

I shall not in any way reduce the risks associated with investing in companies that the market already has a very positive view of, only warn against the attitude that companies with high PE are ”expensive” and thus a bad deal. One aspect that one cannot forget is that higher-valued companies tend to fall more if it becomes a broad decline in the stock market, as well as on the rapportmissar. Many think this is tedious and has therefore aside these companies, which is perhaps rational for them. To do this, however, is the same thing as having a high level of diversification (see previous post), it preserves perhaps the good mood when you look its depåsaldo also days when the stock market falls, but it is hardly the right method to become rich on their investment.

Rich will be by to purchase excellent, fast-growing and profitable companies, at the very time when values are falling, and hold the shares as long as you believe in the company and do not sell or do not dare to buy only for PE is high.



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