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How each company's P/E ratio is calculated

How each company's P/E ratio is calculated
At WayUndervalued.com, the P/E ratio used in the calculation for each company's value estimate is very important, so I am dedicating an entire post to it.

See: How Wayundervalued works

The historical P/E ratio is calculated using the following:

  • Each of the 5 last years non-zero P/E ratio
  • Industry average P/E ratio
  • If any of the 5 single years or Industry P/E ratio are higher than 29, it is capped at 29.  Why do I do this?  Because I have a hard time calling a stock undervalued if the P/E ratio used to calculate that value is really high.

Why not just use the average 5-year P/E ratio supplied on some web sites?  Because many times this data point is too low or too high.  Some years a stock can trade at less than 5X earnings.  Other years, it could trade at over 100X earnings.  For these cases, taking an average is often inaccurate.  I want to automate the P/E calculation for each company and will rarely manually modify it unless the automatic calculation is really far off.

WayUndervalued company P/E ratios are never increased based on an industry P/E ratio.  For example, if the 5-year P/E ratio is 15 and the Industry P/E ratio is 20, the company valuation is not increased from 15.  However, valuations are decreased if an industry P/E ratio is lower than the company's historical P/E ratio.

One future tweak to this algorithm may factor in companies that only have 1 or 2 years of valid P/E ratios.  I don't do this currently, but in the future I may lower the P/E ratio for a company that doesn't have a consistent P/E ratio.

Another possible future tweak would be to modify the "29 cap" either up or down.  Some companies trade higher than this consistently, but for now 29 is the cap.  Maybe one day each user will log in to the site and enter their own cap?  Perhaps..