Today, my article is about to do this:

1 The Future

The price-to-earnings (P/E) ratio valuation appears to be calculated based on the current earnings per share and stock price to value the stock. In reality, what it needs to estimate is the value of the future, not the present. Stock trading is about trading the future. What we investors buy is the future of the company, how much the company will be worth in the future, and how the future performance growth rate will be, these are what we need to estimate. In fact, we use the P/E ratio for valuation to find out how much the P/E ratio of this stock will be in the next few years or decades. However, it is obvious that the future is affected by various factors, and it is difficult for us to know how much the earnings per share will be next year or the year after, so what should we do?

One approach is to assume that the company's performance in the future will be the same as it is now, so we can calculate the future P/E ratio of the company using the current earnings per share.

For example, Industrial and Commercial Bank of China (ICBC) has an earnings per share of 1 yuan this year, and the current stock price is 5 yuan. We assume that the performance of ICBC will remain unchanged for decades in the future, then the P/E ratio of ICBC in the future will be 5 times. We will conclude that the valuation of ICBC is very cheap, because the company can earn another ICBC in 5 years.

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Another approach is to assume that the company's performance in the future will be better or worse than it is now, and then calculate the future P/E ratio based on our assumed earnings per share. For example, ICBC has an earnings per share of 1 yuan this year, and the current stock price is 5 yuan. If we believe that the performance of ICBC will decrease by 90% in the future, we will assume that the earnings per share of ICBC will be around 0.1 yuan for a long time in the future. At that time, the current stock price of 5 yuan will be too expensive. Because the P/E ratio will reach 50 times. ICBC will need 50 years to earn another ICBC. Therefore, it is not worth buying ICBC's stock at the moment.

It is clear that whether the company's performance will rise or fall in the future directly determines our calculation of the P/E ratio, and directly determines our valuation of the stock. The so-called P/E ratio is actually just our judgment of the company's future profitability.

2 Vagueness

From the above discussion, we can see that: since it is difficult for us to estimate the company's performance in the future accurately, our calculation of the company's future P/E ratio is just a vague value, and its error may be very large, even with an error of more than 50%!Therefore, a stock with a price-to-earnings (P/E) ratio of 30 does not necessarily have less investment value than a stock with a P/E ratio of 20. The P/E ratio formula is merely a rough and vague estimation of a company's future profitability and its worth. Over-pursuing precision in the P/E ratio is a misstep in investment. The future P/E ratio cannot be accurately calculated at all. It is inherently a vague assessment.

3 Fundamentals

Calculating the future P/E ratio requires an understanding of the company's current overall fundamentals, as well as making assumptions and projections about the company's future performance by integrating other factors. Without understanding the past, it is impossible to evaluate the future. Clearly, the more we understand the company's current fundamentals, the closer our assessment of the company's future P/E ratio will be to the actual situation. Therefore, to know the P/E ratio of a company in the next few years, we must know the current development status of the company, such as what projects are currently under construction, whether the company's position in the industry is stable, and whether the management's current business strategy is reasonable, and so on. Based on this, we can speculate the company's future performance, and by dividing the current stock price by the future earnings per share, we can assess whether the current stock price is worth buying.

In summary, the P/E ratio is a tool for making a vague assessment of a company's future performance prospects based on the current fundamentals and other factors. It is clear that if we do not have a good understanding of the company's fundamentals and make mistakes in judging the company's future development, our estimation of the company's future P/E ratio will definitely have significant problems.

Therefore, the core of the P/E ratio is to judge the future development prospects of the company or industry. Obviously, this is a challenging task, and each of us may make mistakes in predicting the future. Therefore, Warren Buffett said, "I only do simple math," meaning he only chooses industries and companies with future prospects that he can easily predict for investment.

Over the years, Buffett has invested little in the technology sector, and the success rate is not high. The main reason is that the technology industry is rapidly changing, and it is difficult to estimate the annual earnings for the future. Assessing the future development of a technology company is too difficult. Buffett's current holdings are mainly focused on industries he is more familiar with, such as banks, oil, and retail department stores. Although he is now heavily invested in Apple Inc., it is clear that assessing the future development prospects of such a high-tech company like Apple is somewhat challenging for him, which is an adventure in Buffett's investment life.

So, friends, never think that by dividing the current stock price by the company's earnings per share for this year to get the P/E ratio, it can be used to assess whether the stock has investment value. Making money is not so easy, is it? The essence of using the P/E ratio formula is to calculate the future earnings per share of the company that are not visible to the naked eye at present. This is obviously a daunting task.

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