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Dear Moffat,
Thank you very much for your lectures. I watched your lecture about PE ratio, but I am a little confused with it yet.
Suppose we have a risk free investment, say bank deposit with interest rate of 20%, so we can say its PE ration is 5.We all know the stock market are more RISKY than risk free deposit. So why people will buy shares with say PE ratio of 9 ?? this investment is both risky and also will take 9 years to get back the investment to the investor.
It is more sensible for me that the PE ratio of stock market to be less than 5, but why in the real world the PE ratio of the stock market is always much higher than risk free? I would expect to get back the risky investment sooner than risk free investment, so if its ration was say 2 was far more logical for meThank you very much
PE ratios are not calculated for bank deposits – they are calculated for shares.
It is calculated using the current share price and the current earnings per share. A PE ratio of 9 means that it would take 9 years to get back the investment but only if the earnings per share was going to stay constant.
If shareholders are expecting the earnings to grow in the future (which is likely to be the case) then they will pay more for the shares, but since the current earnings are not changed the PE ratio will be higher.
A higher PE suggests that shareholders are expecting higher future growth.
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