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To: Tunica Albuginea who wrote (791)	1/1/1999 7:48:00 PM
From: Chuzzlewit	Read Replies (2) \| Respond to of 41369

Tunica, you observed <iI had to swallow hard to buy the high PE. One of the first lessons you ought to learn is that PE is a meaningless metric, baby boomer or not. Just consider the following problems: -- A company with revenues close to break-even will have an astronomical P/E that can come down like an avalanche with just a small increase in sales. Here is a hypothetical: suppose we have a company trading at $10 (purely arbitrary choice here) with earnings of $.01. That gives a p/e of 1,000. But suppose you discover that that it had sales per share of say $4.00, gross margin of 50%, and fixed costs of $1.99 per share. Next year it increases its sales by 25%, and everything else is the same. Now you have earnings of $.51/share, and all of a sudden you have a stock trading at a p/e of 19.6! -- P/E is a backward looking metric. It compares last year's earnings to this year's price. So it isn't even an inverted yield, which would compare next year's earnings to the current price. -- P/E is a peculiar metric because it is a stock (price) divided by a flow (earnings). When you do the arithmetic you find out that iut has the unit of "time", because earnings is really $/time. So, in order to get a pure number you need to divide through by an appropriate time parameter. That's why a growth rate is the appropriate multiplier -- you get rid of the time unit that way. -- P/E is insensitive to two of the major drivers of stock prices: risk-free rate of interest and the stream of expected free cash flows. Now you know why I never pay attention to P/E. At best it's yesterday's news. At worst it's yesterday's editorial. TTFN, CTC PS, this is the first I've ever had a discussion with a gonadal membrane.