re P/Es: I'm new to the world of Dell
1. Is anyone concerned about the relatively high P/E ratio of DELL? Will this impair the ability of the company's stock to show significant price appreciation in the future, and to the degree that it's enjoyed in the past?
John, 'relative' to what? (If you want a thorough discussion on P/Es go back and read this thread from the beginning) At the risk of boring some longer-term readers, here it is in a nutshell: A P/E is a statistic, not a measurement device. It supposedly measures the current price compared to an historical datum, the earnings for the past year. There are several fallacies with doing so, here are a couple of them.
First, people toss the term "P/E" around like they know what they mean, when in reality, some are using a forward P/E, some are using an historical P/E, based on the last fiscal year's earnings, and some are using an updated P/E, based on earnings through the last quarter for which data is available. Obviously, this can lead to some diversity, both of the number derived, and the opinions about it. ;^}
Next, a P/E makes no allowance for social change. Here's a simple but extreme example. Suppose that this is the first year that Henry Ford is mass-producing automobiles: You have before you the P/Es of two companies, Ford Motor Company and Acme Buggy Whip. The P/E of Acme might be 5, but that of Ford cannot be determined, because you have no data for the previous year. From the perspective of history, which stock would you rather own?
Third, a P/E is subject to corporate manipulation: since it is only a ratio based on historic earnings data, you are totally dependent upon the corporation accounting officers for accurate and complete data. Fortunately, most companies DO provide accurate data within their capabilities. (DELL shareholders are especially blessed because the CFO, Tom Meredith, is renowned as much for his integrity as his genius.) However, in a greatly diversified conglomerate, even the CFO is dependent on a myriad of others for accurate data regarding all aspects of the corporate body. Further, the management teams of some corporations have been known to deliberately skew the data they report in order to provide market-acceptable earnings data. This practice is especially easy to do using write-offs after a takeover or acquisition. Many analysts supposedly even suspect MSFT of holding back on earnings in especially good quarters to 'pad' the earnings of a potentially less than par quarter. This practice, which some might consider unethical, does help shield the shareholders from greater volatility and swings.
Fourth, a P/E makes no allowance at all for the different natures of corporations. Once again an extreme example: let's compare the P/Es of Cisco (CSCO: 80.7, a maker of internet networking and communications equipment), PG&E (PCG: 16.9, a utility), Amazon.com (AMZN: *, an on-line book store) and Bethlehem Steel (BS: 12.65). Note also, that the P/E makes no allowance for dividends. Which stock would you rather own? Can you make a decision based on their P/Es? So, I would submit to you that a P/E only has any metric value when comparisons are made about similar companies within the same industry.
(* indeterminate, because it's never had any earnings.)
Fifth, a P/E makes no allowance at all for future growth. At one time in the past, you could have bought DELL or IBM when they had identical P/Es. IBM was expected to grow at an annual rate of ~10%, and DELL (few had heard of DELL back then) might have been expected to grow at an annual rate of 25%. Based on P/E alone, they were equal buys. DELL would have carried more risk, but also greater chance of increased profits.
Although I am sure that there are others, those are some of the more serious flaws with judging a stock by P/E. Now, in an attempt to make the P/E a more viable metric, some folks devised a Forward P/E, or Price/Estimated Earnings. Although better, the forward P/E contains many of the same flaws inherent in the P/E concept, with the additional one that forward looking estimates are, shall we say, "subject to change".
The next step was the PEG, or Price/Earnings/Growth, to try and
develop a tool which would provide some insight into equity potential. (Go back and see which weaknesses of the straight P/E would still apply here.) Assuming that all data is accurately reported (somewhat dangerous), the PEG probably does have some application.
Dr. Paul Levy, aka Chuzzlewit the Cat, has taken the concept one step further, and uses a normalized PEG (CNPEG). That is, he compares the PEG of one company to the PEG of an index or group of similar stocks. I consider the CNPEG to be the best PE tool available, but is obviously more time-consuming and tedious to calculate. Remember, though, for the company you are interested in, it STILL requires accurate data input.
Hope that addresses the P/E issue.
DELLish, 3. |
