Ok, I get that the higher the flow through rate and low the inflation the better for a company, but why is a company with a high P/E valued higher than one with a lower P/E? My brain is fried and maybe I’m just missing something, but wouldn’t it be better to have a lower price co. with higher earnings making the P/E value lower? uggh I need a beer.
if the benchmark P/E is above your firm P/E then the firm is undervalued…comparable implies the same earnings yet the price for your company is lower then the benchmark and hence undervalued…
When you use the P/E formulas you’re not calculating the P/E that the stock is trading at. You’re calculating a justified P/E based on reported figures and comparing it to the P/E that the stock is trading at to see whether it’s under or over valued.
So just to be clear, say both firms have a 80% flow through rate, but firm A has inflation of 6% and firm B has 4% inflation. Req. return is 8% for both firms. Firm B is valued higher than firm A because of the lower inflation rate, even though it has a higher P/E?
P0 / E1 = 1 / [real required return + (1 – inflation flow-through rate) × inflation rate] Firm A p/e 10.87 Firm B p/e 11.36 Even though Firm has a higher p/e it valued higher becuase of a lower inflation rate?