This is from Schweser, in discussion about a cyclical firm: “Earnings will follow the economy, and prices will reflect expectations about the future. Thus, most of the time, the P/E multiple of a cyclical firm will peak at the depths of recession and bottom out at the peak of an economic boom.” This threw me off, because the text constantly mentions that high P/E ratios are high growth firms, and low P/E ratios are indicative of low growth firms. So, wouldn’t you expect the P/E of a cyclical firm to peak in a boom (where it’s most overvalued), rather than the depth of a recession? Wouldn’t you similarly expect the P/E to bottom out in a recession, (where it gets most undervalued)?
Its like this: Earnings follow Economy - So when economy is down, earnings are down too… in deep recession they are lowest. Price reflects expectations for future so when the economy is bottoming out… prices will begin to rise. In recessions : P/E= higher numerator/lowest denominator, hence it peaks.
Ok, so to summarize the view you’re taking is: In a recession, the numerator P is higher (due to expectations of higher future prices when economy rebounds) and the denominator E is lower (due to earnings following the economy, which is currently in a recession). Thus, high P/E. The reverse is true for booms. Thanks a lot–I think I initially confused industry phases vs. phases of the economy when comparing to P/E.
aka moledovsky effect
awesome now i remember. thank you both.