“The Price/Earnings ratio is a very simple measure of the ‘value’ a company has. The Price is the current share price and the Earnings is usually the sum of the last 12 months’ earnings per share,” Horace Dediu writes for Asymco. “In other words it measures how many of the last year’s earnings are built into the share price. Put yet another way it’s the answer to the question ‘If earnings don’t change, how many years will I have to wait before I’m paid back for my share purchase with retained earnings?'”
“So a company with a P/E of 10 implies that if nothing changes, in 10 years a share owner would ‘earn’ back the price they paid for the share,” Dediu writes. “Any earnings after 10 years would be “profit” for the share owner.”
Dediu writes, “So with a company growing at 20% the “realized P/E” is 5. You realized the price of $100 in five years’ worth of earnings… Investing in Apple between 2006 to 2010 meant obtaining a payback period of less than 4.5 years, on average. In other words, regardless of what the trailing or forward P/Es getting quoted at the time, buyers actually paid for only about 4.5 years of earnings. In other words they actually bought Apple for a P/E of about 4.5.”
Much more in the full article – recommended – here.
[Thanks to MacDailyNews Reader “Dan K.” for the heads up.]