Investors look at a variety of valuation multiples when making investment decisions. A fundamental valuation multiple investors traditionally look at is the PE ratio which is the ‘Price-Earning’ ratio. The PE multiple is calculated by dividing the share price/earnings per share or Equity Value/Net income.
Traditionally, the PE ratio has hovered around the 10-15x range. Of course, the good companies have taken on valuations on the higher end (around 15x earnings) and mediocre companies around the lower range (around 10x earnings). Exceptional companies with high growth and good operating margins have seen PE ratios around 30x earnings. These include well-regarded companies such as Google, Apple, and Microsoft. Many analysts have been screaming overvaluation whenever they see high PE ratios!
Today, we see many companies valued at 100x earnings. Many of these companies do not even have earnings. Can we justify these valuations? When? We address these questions here.