It's Time for Investors to Abandon the P/E Ratio (for Now)
The price-to-earnings (P/E) ratio is among the most popular valuation multiples, and perhaps the most important for investors, but it has limited explanatory value when earnings per share are volatile.
Profits are a measurement of success over the long term, allowing a company to invest in further growth or return cash to shareholders. Intrinsic valuation methods championed by investors such as Warren Buffet and Benjamin Graham base share prices on the predicted future profits and cash flows of the underlying company. Thus, a metric relating stock prices to corporate profits can be powerful, but the current market and economic conditions are complicating P/E ratios.
Using P/E is not always straightforward. Obviously, it is only applicable to companies that have earnings. It can also present problems for businesses with volatile results, as is the case with cyclical industries such as homebuilding, hospitality, semiconductors, and materials. This issue becomes especially relevant under the current circumstances, in which many businesses are experiencing temporary shocks caused by the coronavirus. Distorted results in the second and third quarters of this year, as well as an uncertain outlook for 2021, cause trailing and forward P/E to be misleading for many stocks.
Source Fool.com
