Do we want a high P/E or a low P/E? For example, if the inflation flow-through rate is 100%, a firm has a higher P/E than a firm with an inflation flow-through rate of 50% (page 213 of equity textbook). “In other words, the less a firm is able to pass inflation through its earnings, the more the firm is penalized” meaning THE FIRM HAS A LOWER P/E RATE. That being said, I thought we want a low P/E, literally (Price/Earnings)…meaning don’t we want a low price and high earnings, which would generate a low P/E ratio? It’s pretty fundamental, but I’m a little confused. Can someone please help me out with this?
It’s more relative. When valuing two entities you want the one with the lower P/E, as it is more attractively priced.
P/E The E in the denominator is suppose to represent “normal” EPS. Earnings that include only recurring components at mid-cyclical level (you want to measure,compare and use firm earnings at the middle of the business cycle.) Inorder to get to this underlying earning figure you have to adjust for items that are extraordinary (ie both infrequent in occurence and unusual in nature).These include but are not limited to lawsuits or gain/loss from a sale of a subsidiary. Nonrecurring item would be restructuring provisions. These items can be unusual in nature or infrequent in occurance but not both. for comparison purposes you also have to adjust for inventory method and COGS Price/Earnings measure the price you are paying today for 1 dollar of future earnings. the lower the better.