A Common Intermediate Investor Mistake

Using a stock’s price-to-earnings ratio can be a useful metric when the following four conditions exist: (1) interest rates remain in a narrow band; (2) the growth of the enterprise is consistent through the decades; (3) the quality of the balance sheet and general risk profile remain closely the same; and (4) the stock is non-cyclical. All of these character traits need to exist, otherwise the use of historical P/E ratios can be a red herring rather than a helpful investment aid.

Companies like AT&T or Realty Income deserve higher P/E ratios when interest rates are 2% compared to 8% as the purpose of the investment is usually a quasi-bond with a growth kick compared to something like Visa where the purpose is long-term future growth.

Also, the growth rate of the company needs to remain consistent, otherwise you will be using historical data that assumed different characteristics when making … Read the rest of this article!