Schweser LOS32 p137-138 - Value / Growth Investor investor, investing, future, multiple

Carson

Hi,

Just wondering if anyone gets the logic behind what the book is trying to say.

It states for value investing investors look at the numerator in price multiples (e.g. P/E, P/B). They look for low price multiple.

Then it goes on that the justification for these investor is that the firm's earnings are depressed now and will rise in the future and revert to the mean level.

What the heck does that even mean? If the earnings are depressed shouldn't the P/E be HIGHER (and thus justifying for HIGHER P/E?)

The second point for these investor is that growth investor expose themselves to risk of price multiples and earnings will contract for high price growth stock.

I'm guessing this one is arguing against high P/E stocks.

Can someone please clarify? I've been reading the same page for an hour.

skycfa

1) P/E
Example : 10/5 = 2 (low; hence value stock), 15/5 = 3 (higher; Market average)

Comment: With the same level of earnings (5) the price is lower (10) compared to 15 (industry average)

Reason (why would this happen): The numerator (P) is based on "Future/Projected" earnings (Gordon growth model) while the denominator (earnings per share) reflects historical performance. An unfavorable future outlook in earnings can depress the price even with same "current" earnings which leads to lower price multiples. Reasons for depressed future "expected" earnings can be seasonality/M&A which in time will correct and earnings will return to risk adjusted industry average resulting in a higher price multiple.



2) Same logic goes

For same level of earnings price can be higher due to higher (than industry average) "expected" earnings which results in high price multiple (growth stock). BUT if growth does not materialize than the multiple will revert to industry average (risk of price multiple)

Hope it helps

IAmNeil

i take it that Low P/e means lower than its average and the stock was downgraded before due to weak earnings.

as the firm's earnings rise, the stock will be rerated , and to justify higher earnings price will also increase until the P/E revert to its average or possibly higher.

and as for the growth stock, as the the growth slower, the stock will be rerated downward thus the stock will be value at lower price multiple.

thats what i think