The Importance of Updating your P/E Ratios

It’s warm and Sunny here in Cleveland, surprisingly (we’ve even had 2 straight days of sun!), in the middle of February.  Here I thought the groundhog said we were in for a brutally long winter!  However, I didn’t realize we were in for a brutally rising stock market, either!  This has brought in new traffic on this dividend investing highway and one thing I have learned over this past/last weekend is – one should update the expected forward earnings per share on at least a quarterly basis, and I’m here to tell you why you should be doing just that.

Importance of Earnings Per Share & P/E Updates

Now that another full year and quarter-end (i.e. 12/31) are more than fully behind us, companies are releasing their press releases and annual reports, i.e. 10-K’s.  Being a public accountant and an external auditor, I review and audit my fair share of these.  However, what this also means is that another year of “actual” earnings figures is in the books and investor calls, press releases and investor presentations have been underway.  But what does this mean for us dividend stock investors?  Well, we need to go back to the drawing board and or research on companies, as the price to earnings ratio, one of our amazing dividend diplomat stock screener metrics, is more than likely out of the norm and also outdated.  Yes… I know, you cringed, you actually have to do a little homework here : )  Due to the recent surge of the market since 1/1, +5.02% (2/19/17), if you had old/lower earnings metrics in your spreadsheet that you maintain for research, then your price to earnings ratios are more than likely higher than normal!  Obviously, earnings could have worsened, but that has not been the trend I’ve been seeing, as well as the forward earnings projections, thanks to the potential tax changes.  Therefore, one needs to go back and update these earnings per share figures, so that you can get a more realistic via of the companies you are evaluating – either in your own portfolio or on new targets.

Considerations beyond current EPS!!!

Not just any old, end of year, actual-earnings per share figures.  I am actually referring to the forward looking earnings per share.  First, this information is easily accessible, and if you are reviewing/screening for “easy to understand businesses” (think Procter & Gamble (PG), Target (TGT), Consolidated Edison (ED) or… yep, you guessed it – the top 5 foundation stocks for dividend investors), I guarantee you there are more than 10+ stock analysts that are reviewing/watching/analyzing your company, and placing an earnings target.  I use the average earnings estimate for the up-coming year, and update as each quarter goes on.  I prefer investing on the forward earnings potential of a company, as opposed to what they’ve already done, though the proof of how they perform definitely can be seen from past results, so don’t dis-consider prior history fully.

Why is this so important… NOW?

Easy.  With the stock market flying high and up over 5% already year to date, to note – this is only through 50 days of the calendar year, not having updated earnings per share numbers more than likely (if they are lower), is going to display that each company that you own, more than likely, is either closer to being over valued, is overvalued or is even more overvalued than before.  For example – for Johnson & Johnson (one of my top stocks for 2017), I was using an earnings per share figure of $7.14 instead of the new average based on the latest releases, of $7.38, this causes the P/E to go from  to 16.7 to 16.1.  Not a huge difference in this situation, but then you have Visa (V), where in my spreadsheet i had $2.59, which at a price of $87.46, led to a P/E of 33.77 (YIKES).  However, after reviewing what analysts are expecting, this earnings per share turned to $3.87, which dramatically reduced the p/e ratio to a palatable 22.6.  Visa went from an over-priced stock to a reasonable valued one, and you could even compare this to the S&P and argue that it could be a smidge undervalued.  Talk about a swing!

Concluding thoughts on updating p/e Ratios

All-in-all – what this comes down to is using the most accurate information in order to make a decision.  You don’t want to be the person making a decision with your money based on stale information that doesn’t correlate to the business today, do you?  This could obviously go the other direction, where current year earnings was $4.50, but the outlook is less than that, causing the P/E ratio to be lower now than it does look in the future – therefore, you need to take that into consideration.  I plan on ensuring/having calendar reminders to update the entities that I hold quarterly, in order to capture any change or adjustment to earnings going forward and the impact to the p/e ratio.  This actually takes me only 5-10 minutes each time, so we are still talking less than an hour of work here!

What do you think about updating your earnings per share figures?  Do you wait until after the full year is over to evaluate?  Are you constantly updating them based on actual quarterly figures and annualizing those current figures?  OR are you employing something similar above, and using forward earnings per share to project the forward P/E ratios?  Would love to see what methods everyone uses, what thoughts they have about what I’m doing on a going forward basis and/or how often you even look at the P/E ratio, as well as updating your screening metrics!   As always, appreciate everyone for rolling through the Diplomats territory and talking investing, savings, strategies, you name it.  Talk soon and keep staying focused on the journey : ) Talk soon!

-Lanny

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13 thoughts on “The Importance of Updating your P/E Ratios

  1. I often find myself on Fidelity doing research and comparing stocks to their trailing 3-year & 5-year P/E ratios. This is a rather simplistic evaluation. But if a company is trading at a P/E way above historical norms and I can’t research and find reasons to explain this, I find myself itching to sell or not buy, whatever the case may be.

    Same goes for ones trading far below these historical norms. I’m a bit of a believe that most blue-chip stocks will always progress or regress to the mean, unless of course that has been some massive fundamental operating shift in the company.

    Just another thought to add to you P/E points above! Great article, and this is definitely very important.

    • Stacker –

      Great point there – most big blue chip and/or dividend aristocrats won’t have terribly low price to earnings – because of their pure fundamental nature. Typically when they do it is very fast and sudden, and that opportunity is gone. Such a big point. Thanks for sharing stacks, talk soon.

      -Lanny

  2. I’ve owned J&J for years and it’s one of the few stocks I’d keep buying in 2017. Target is another one that I’d buy on the recent pull back – I own $10K worth of TGT so it’s already a decent size in my portfolio. There are too many things I like in today’s market.

    Thanks for posting and keep it up!

  3. Although I don’t have a spread sheet with this information, I closely monitor P/E changes every quarter. It keeps me updated on the earnings of my companit’s and allows me to get a better idea on where they stand financially. That’s why I feel it is best to have a smaller dividend portfolio with a mix of great companies rather then some dividend investors I see with over 60 stocks in a portfolio. Way to much to track!

    • Diligent –

      Glad that you are monitoring the metric, first and foremost. I agree, it can become a little more time sensitive with more companies, but if they are strong fundamentally sound – should be okay, regardless : ) Luckily, I spend about once per quarter and then go to a site to crank in the tickers and pull down estimated earnings. Takes about 15 minutes or so, but gets me there. Thanks for sharing DD.

      -Lanny

  4. What I find tough is the “adjusted figure” that managements often give. They often say that these are “one offs” but they often seem to happen year after year. Buffett actually wrote about this in his letter this year. I still think that you are better looking at several years worth of earnings to try and smooth out both the business cycle (although it has been a while since a downturn!) and all these “adjustments”. Never forget to analzye the cash generated as well – that is where the dividends have to come from.

  5. I have built myself a hand spreadsheet with the yahoo finance API built in. It’s great for a quick snapshot of my portfolio and what stocks I like to keep an eye on. It really suits my need and best of all yahoo allows anyone to have the API access for free.

  6. The biggest issue with the forward metric is the reliance on an analyst’s best guess. How many were blindsided by TGT’s report yesterday, how many updated their forward estimates and how many incorporated the fact (illustrated by mgmt) that a turn around was (minimally) two years out and would incur additional costs in store conversions and IT expense? An issue similar to ones raised by stacker and mike.

    • Charlie –

      Of course, of course, you will definitely have your big “miss” on the estimate. Did you, by any chance, seize the opportunity, by the way, at TGT? Or waiting for some dust to settle? Quite the yield now for an aristocrat… haha

      -Lanny

  7. The googlefinance function on google sheets is where it’s at. You can easily set a cell to look up current price and another to look up most recent ttm EPS. This gives you a mostly constant, up to date P/E ratio. There will be a lag between when companies publish their earnings each quarter and when google updates their data, but in my experience it’s not a very long lag. Google’s robots are really fast.

    Having current data is one thing. Whether it’s worth anything or not is something else entirely. For me “earnings” are not nearly as meaningful as cash flow. I like the old saying : “profit is imaginary; cash flow is fact”.

    Unfortunately the google finance function doesn’t look up FCF so I’m still doing lots of homework.

    As for “future” or “projected” earnings go, you can throw those in the round file.

    Revisit the chapter in The Intelligent Investor on analyst’s projections. Ben Graham’s take on the subject is as true today as it ever was.

  8. I pick my dividend stocks with a P/E ratio somewhere between15-to-25 based on current rather than forward P/E valuation. I think either way works fine. Occasionally I will accept a higher P/E ratio for a top performer. After that, I use the interactive charts and look at the prior 2 year history and I will set the top price I am willing to pay for the stock based off that. I used to do this about every quarter, but ever since Trump won the election, I have been re-evaluating monthly just because valuations have been changing so fast. For the most part, that method has worked well for me, even though nothing scientific or genius about the technique. Since Trump became the President-elect, I have been using both, the 1-yr & 2-yr charts along with 50-day, 100 day and 200 day moving averages to decide what I consider a fair price! The stock market has shot up so fast, the 2 year trends for a lot of stock prices have been left in the dust. If for some reason, stock prices start falling as fast as they rose, I may lose some but I will not lose my shirt. As Buffet says, “You don’t have to swing at every ball pitched.”

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