I have to say that most people seriously underestimate the price-to-earnings ratio valuation method, and their understanding and application are not deep and flexible enough, as shown in the following:

1. The premise of not thinking about the price-to-earnings ratio

Many friends take a direct look at the P / E ratio and make an overvalued or undervalued judgment on the stock, without thinking about the premise of using the P / E ratio valuation method at all. Before formally analyzing the premise hypothesis of the price-earnings ratio, let's review the definition, calculation formula and type of the price-earnings ratio.

The price-to-earnings ratio, which refers to the share price per share of a listed company divided by earnings per share, is essentially the number of static payback years regardless of the time value of the currency. In popular terms, suppose a listed company's current market capitalization is 10 billion, and the company's annual net profit attributable to the shareholders of the parent company is 1 billion, then the company's price-to-earnings ratio is 10 times, in other words, as an investor, if you buy the listed company for 10 billion, it will only take 10 years to earn back the principal invested. Therefore, the so-called price-to-earnings ratio of 10 times earnings refers to the capital recovery time, which in this case refers to the 10 billion principal that it takes investors 10 years to recover without considering the value of time.

The reciprocal of the price-to-earnings ratio, that is, the rate of return. In the previous example, the principal invested by investors is 10 billion, and the company can make a net profit of 1 billion a year, so the annualized rate of return on this investment is 10% (= 1 billion / 10 billion).

Going back to the current year and the rate of return is the initial understanding of the price-to-earnings ratio valuation method.

From this, you can think carefully, in the above example, when using the price-to-earnings ratio, what is the implicit premise?

Or, to change your way of thinking, you can ask yourself:

1) the company has made a net profit of 1 billion this year, is it guaranteed to earn 1 billion next year, and is the sustainability of the profits guaranteed? What if the performance is relatively poor next year and only earns 500 million? Or if it earns 1.5 billion more than expected, is it still appropriate to use the current price-to-earnings ratio to value the company?

2) is it really trustworthy that the company has made a net profit of 1 billion this year? How credible is it? What if the company falsifies or adjusts its finances, falsely increases profits or hides profits? After all, listed companies have too many means of financial adjustment, and many of them are reasonable and legal.

3) the company has made a net profit of 1 billion yuan this year. What is the real profit quality? Is the 1 billion earned in cash, or is it just a net profit in the accounting sense?

4) the company has made a net profit of 1 billion yuan this year, but due to periodic factors, the company's net profit will change from profit to loss next year, so how to use the price-to-earnings ratio valuation method in the case of losses?

Similar problems can be extended a lot. If we think deeply about these problems, we will find that every time we use the price-to-earnings ratio valuation method, we unwittingly accept these three core hypotheses: a. The profit of this company is real, not the result of financial fraud or financial adjustment. The profit quality of this company is very high, there is not much water, and it is basically earned in the form of cash; C. The profit of this company is sustainable, there will be no big ups and downs, or even turn from profit to loss.

In short, before using the price-to-earnings ratio valuation method, investors need to think: is the company's net profit true or false? Is it cash? Is it sustainable? Is it enough to cover the company's cost of capital? (that is, there is an advanced concept of EVA, which will be introduced later in the course)

This is the premise of the P / E ratio, that is, the P / E ratio is suitable for listed companies with true, stable, sustainable and high quality earnings. If the profitability of the underlying company does not meet the above assumptions, then using the price-to-earnings ratio to value it, it must be adjusted accordingly, or even replace other valuation methods, after all, the valuation method is not just the price-to-earnings ratio.

two。 The valuation method of price-to-earnings ratio is equivalent to valuation

In addition to not thinking about the premise of using the price-earnings ratio, a mistake that many people often make is to equate the price-earnings ratio valuation method with the valuation method. No matter what industry or which life cycle listed companies are in, they all blindly apply the price-earnings ratio valuation method. It seems that the price-earnings ratio valuation method is regarded as a universal method, as if in the world, there is only the price-earnings ratio valuation method. It's not right. It's too narrow. If you think of valuation as a variety of household tools, investors should not just use a hammer-price-to-earnings ratio, otherwise it is easy to see who is a nail. The seven cases in this series will fully demonstrate how to use other valuation methods when the price-to-earnings ratio valuation method is not suitable.

The reason why the price-to-earnings ratio valuation method is so widely used is related to its wide variety (static, rolling, dynamic and annualized), easy to calculate (both static and rolling price-earnings ratios are based on historical data), low cost of understanding (static return years, reciprocal is the rate of return), and reasonable inherent logic (linking the company's market capitalization to its profitability). But this does not mean that the price-to-earnings ratio valuation method is omnipotent, valuation is a discipline, not to mention that various valuation methods are only a part of the discipline, even as far as valuation methods are concerned, the price-earnings ratio valuation method is only one of the relative valuation methods for enterprises that meet the sustainable operation hypothesis.

Only as far as the relative valuation method is concerned, there are price-to-earnings ratio relative profit growth ratio (PEG valuation method), price-to-book ratio (Pmax B valuation method), price-to-sales ratio (Pmax S valuation method), price-to-present ratio (P/FCF), enterprise value multiple method (EV/EBITDA) and so on. Under the absolute valuation method, there are dividend discount model (DDM), free cash discount method (DCF), net asset value method (NAV), residual income model (RI), economic value added model (EVA), adjusted net value method (APV) and so on.

Of course, no matter how many valuation methods are, they are just tools, and the most important thing for a company's valuation is investors' perception of the company, especially the judgment and forecast of future earnings.

To sum up, when valuing listed companies in the future, on the basis of a full understanding of the fundamentals of the company, investors should consider using a variety of valuation methods, not limited to the price-earnings ratio, especially when the price-to-earnings ratio valuation method is not applicable at all.

3. Do not understand the practical application of price-earnings ratio in investment

If you see the third subtitle, some readers may not be convinced. It doesn't matter. You can think about the following questions:

One: which profit should be used to calculate the price-to-earnings ratio? Do you use the net profit disclosed in the financial statement directly, or the net profit attributable to the shareholders of the parent company (referred to as the return net profit)? Or is it net profit after deducting non-recurring profit and loss (non-net profit for short) or adjusted net profit (Non GAAP or Non IFRS net profit for short)? For a detailed introduction of profit subjects, you can refer to the previously written "When we talk about 18 kinds of profits, what are we talking about?》。

Second, according to the different duration of the use of homing net profit, the price-earnings ratio can be divided into four types, namely, static price-earnings ratio, rolling price-earnings ratio, dynamic price-earnings ratio and annualized price-earnings ratio. When actually studying the valuation of a company, which kind of price-to-earnings ratio should be used? And what is the reason behind it?

The suggestion of this paper is to give priority to the dynamic price-earnings ratio, supplemented by the rolling price-earnings ratio.

1) first of all, for the static price-earnings ratio, the reason for the low reference value is that last year's net profit is already in the past and has no strong causal relationship with the enterprise's profitability this year and in the future. after all, investment is more focused on the future profitability of the enterprise.

2) secondly, for the annualized price-to-earnings ratio, the reference value is the lowest, because on the one hand, the calculation method of return-to-home net profit is unscientific and has serious logical defects. For example, if a company is at a loss in the first half of the year, its annual return net profit is also at a loss on an annualized basis. On the other hand, in the actual operation, some enterprises have obvious off-season and peak season. When some enterprises happen to enter the off-season, the return net profit in that quarter will be very low or even negative, resulting in a falsely high price-to-earnings ratio; similarly, when some enterprises enter the peak season, then the current quarter return net profit will increase substantially, at this time to convert adult return net profit, and will cause the price-earnings ratio to appear very low, perhaps only 8 or 9 times, which is unreasonable.

Therefore, the defect of annualized P / E ratio is very obvious, and it is easy to distort the annual return net profit of the enterprise, thus distorting the return net profit, resulting in the calculated P / E ratio is meaningless.

3) for the rolling price-earnings ratio, it reflects the current price-earnings ratio relatively objectively, because it uses the return net profit of the last 12 months, and it is constantly rolling and updated, which reflects the real earnings of the enterprise in a more timely manner. But its defect is still does not reflect the future, after all, investors buy stocks, the current performance does not mean that the future performance continues to grow, if the future performance decline, then the rolling P / E ratio will be higher, so the rolling P / E ratio is only suitable for enterprises with sustained and steady growth in performance. However, even enterprises with stable performance may have non-recurring profits and losses in a certain quarter, then the return net profit of enterprises will be distorted, resulting in the distortion of price-to-earnings ratio. Therefore, it is suggested that the rolling price-earnings ratio should be used as one of the reference indicators to evaluate whether the enterprise valuation is fair or not.

4) finally, dynamic price-to-earnings ratio. From a logical point of view, the expected return net profit as the denominator is the most reasonable, after all, investors buy enterprises buy the future, only optimistic about its future profitability, will consider buying. However, the dynamic price-to-earnings ratio is a double-edged sword, which requires investors to forecast the return net profit correctly, otherwise, if the forecast is wrong, it will mislead investment decisions.

To sum up, if investors are more sure that they can predict the return net profit of the covered target, then they can consider dynamic price-earnings ratio as the main factor, supplemented by rolling price-earnings ratio.

Third: in addition to the above two points, there are also such as: how to view the valuation center of a company? How to conduct a specific analysis of comparable companies, and how to adjust the valuation between comparable companies? Why are the price-to-earnings multiples of listed companies in the same sector so different? What is the scope of application of the price-earnings ratio valuation method? Which company is suitable to use price-to-earnings ratio and which company is not suitable to use? For loss-making enterprises, how to use the price-earnings ratio valuation method? Why is the enterprise value multiple (EV/EBITDA) an advanced version of the price-to-earnings ratio? And what is the difference and relationship between the price-to-earnings ratio valuation method and the PEG valuation method?

For these issues, in this series of seven price-to-earnings ratio valuation cases, basically will be involved, please look forward to it.

For those who are interested in the valuation course, you can click on the bullpen class to learn systematically. In addition, if you usually have any questions about valuation, you can also answer them together regularly in Niuniu @ me (my Niuniu number: 13080405; nickname: Yang Jinqiao).

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