29-08-2023, 05:52 AM
If your neighbour just sold his house for 500k you would probably be right to think that you could sell your house for the same price. You might think you could get a bit higher as you had your car porch extended.
Using this analogy, you might think that just because the peers of a company have an average PE of 15, you may think the company is cheap as its PE is 10.
But there is a danger of using relative valuation for stocks. When you compare house prices, you would not think of comparing a similar house design in the US with one in Indonesia. But when using multiples for stocks, many forget that no 2 companies are alike.
My personal experience in running companies is that when you ask management why the competitors are selling better, the answer would be that the competitors have better products or in better markets.
But when people look at relative valuation of companies, they forget the differences and think that just because they are classified into the same sector, companies are apple-to-apple comparable. What works for valuing houses does not automatically work for valuing companies.
There are of course other reasons why I don’t use PE for valuing companies, but these are stories for another day.
If you want to know more about how I value companies read my article “Do you really want to master value investing?”
Using this analogy, you might think that just because the peers of a company have an average PE of 15, you may think the company is cheap as its PE is 10.
But there is a danger of using relative valuation for stocks. When you compare house prices, you would not think of comparing a similar house design in the US with one in Indonesia. But when using multiples for stocks, many forget that no 2 companies are alike.
My personal experience in running companies is that when you ask management why the competitors are selling better, the answer would be that the competitors have better products or in better markets.
But when people look at relative valuation of companies, they forget the differences and think that just because they are classified into the same sector, companies are apple-to-apple comparable. What works for valuing houses does not automatically work for valuing companies.
There are of course other reasons why I don’t use PE for valuing companies, but these are stories for another day.
If you want to know more about how I value companies read my article “Do you really want to master value investing?”