Valuation Series Vol.1 : Median P/E Ratio

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The Price to Earnings, or PE, ratio is used to guage how much investors are willing to pay for each dollar of earnings a company, or group of companies, earn. It’s easiest to think of this as a unit price at a grocery store. One fail-safe for using this metric to view a company before you impulsively buy, is that a company with negative earnings (losses), will not generate a ratio. It is usually best to stay away from these long-shots, at least in my eyes.

Using the median Price/Earnings ratio of a broad index like the Russel 1000 Index helps us to escape some of the noise off a straight average. For example, in a market-cap weighted index, the largest companies have the most pull on the calculation. This shows us what the middle-of-the-pack company is doing. My calculations are guilty of survivorship bias, as the pool of companies has shrunk over the years and the available data I have is not as extensive as I’d like. Either way, working with what we have, we find that, despite the new market highs and the duration of this trough to peak, the median company is just a tad above it’s average.

The abnormally large Cyclically-Adjusted-PE-Ratio, made famous by Robert Shiller, may be influenced a bit too much by the likes of FANG. It is important to keep in mind though, that there are many tools for generative a point of view, and this is just one of them.

Source: Bloomberg