The Alchemist wrote:Jake Sully wrote:The Alchemist wrote:Jake Sully wrote:You can buy if the product of the PE times and price/book value does not exceed 22.5. Hope other factors are constant.
According to your formula, even a maximum 22.5 is way too much to pay to buy ! The inverse (100 divided by your formula PE times into Price / Book Value) is the ROE (Return on Equity). So at 22.5 indicates a ROE of only 4-5 %, which is way to low considering the current rate of Inflation and Interest Rates.
I would expect an ROE of approx 10-15 % so as per your formula, maximum i will pay is 7-10 (the product of PE times Price/Book Value).
Only caveat is i would revalue Net Assets by Marking to Market, and not blindly taking stated Book Value in the Accounts.
Its not that the price should be 22.5. and book valu mean NAV here. for example, lets say, price/earnings is 15. price/NAV is 1.5. so the product is 22.5. so you can go on buy that company whatever the share price is. this is far too a general approach for a defensive investor. You should prefer price/NAV to be very low for better results. You may have to eliminate lots of shares from your favorite list if you apply this in current market level.
exactly what i'm saying ! If you buy a stock with a p/e of 15 and Price / NAV of 1.5, your ROE is only 4-5 % which is way to low and not attractive ! As per your formula, the max number should be 7-10 so that ROE is 10-15 %.
So going back to your example, if the p/e is 15, then Price to NAV should be 0.5 to 0.67. If the Price to NAV is 1.5, then P/E should be 5-7. These numbers ensure that the ROE is around the 10-15 %.
You may fine tune it according to market conditions. But tell me couple of companies with ROE of you choice, I.e. with the above number 7-10.
Last edited by Jake Sully on Sat Apr 13, 2013 9:37 pm; edited 1 time in total (Reason for editing : Cc)