“P/E ratios are higher in an early expansion period when interest rates are low and earnings prospects are high.”
If the earnings are high, shouldn’t the P/E be lower?
Thanks!
Earnings aren’t usually high because the company is aggressively investing in growth at this time. If you think about how all these costs affect EBIT you can see why the multiple would be so high.
Think about this in a startup context–lets take Netflix as an example. As of 1.22.17 the stock is trading at something like 142 times earnings. All that future earnings growth is already priced into the stock BECAUSE of its meteoric growth rate. At the same time, however, Netflix is aggressively investing in original programming/content to maintain its moat against competitors like Amazon Prime etc and its total earnings are much lower than an established behemoth like say, Time Warner.
if interest rates are low stock prices tend § to go up…why
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to value a company you discount it at a lower IR, so P goes up
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lower cost of borrowing will increase both P and E (greater profits)
Re-read your quote. “Earnings prospects are high”. This means high growth is implied, and investors are going to pay a higher multiple for growth.
“Earnings PROSPECTS are high” - meaning future earnings are high but doesn’t mean current earnings are high and thus a high P/E because investors are willing to pay for the prospect of earnings in the future.
Like everyone has already said. But I always like to think of it in real life perspective to help.
Facebook had crazy valuations before it was even making a profit because it had super high earnings potential 10 years down the line. Ever since the market bust in 2009 and rates dropped. All these companies were refinancing and borrowing money because it was dirt cheap and valuations continue to go up from that as well.
Guess I need a break now…Thanks everyone’s help!!!