Assume that you are an investment analyst. Describe and evaluate the rules of thumb employed by you to establish benchmark price- earnings multiples.
Answer on Question #50887, Management, OtherP/E is the most popular valuation ratio used by investors. It is equal to astock's market price divided by the earnings per share for the most recent four quarters. The nice thing about P/E is that accounting earnings are a much better proxy for cash flow than sales. Moreover, earnings per share results and estimates about the future are easily available from just about any financial data source imaginable. The most useful way to use a P/E ratio is to compare it with a certain benchmark. Good benchmarks are the P/E of another company in the same industry, the P/E of the entire market, or the same company's P/E at a different point in time. Each of these approaches has some value, as long as you know the limitations. For example, a company that is trading at a lower P/E than its industry peers could be a good value, but even firms in the same industry can have very different capital structures, risk levels, and growth rates, all of which affect the P/E ratio. All else equal, a firm that has better growth prospects, lower risk, and lower capital reinvestment needs should be rewarded with a higher P/E ratio.