#37 - Analyzing P/E Ratios

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Graham Schroeder
December 20, 2024

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This week contained merger talks and U.S. investments for 2025 and why you should analyze P/E ratios when researching investments.

Market Recap

  • AbbVie ($ABBV) to Acquire Nimble Therapeutics for $200M

    • Nimble's lead asset is an investigational oral peptide IL23R inhibitor in preclinical development for treating psoriasis. IL23R is a clinically validated therapeutic target in certain autoimmune diseases.

    • The acquisition includes a pipeline of other novel oral peptide candidates with potential applications across several autoimmune diseases, addressing significant unmet medical needs.

    • This strategic acquisition is expected to strengthen $ABBV immunology pipeline and represents a significant growth opportunity by combining Nimble's platform and assets with $ABBV clinical expertise in immunology.

  • SoftBank CEO Announced a $100 billion Investment in the U.S.

    • CEO Masayoshi Son announced a $100 billion investment by the Japanese multinational conglomerate in the U.S. promising to create 100,000 jobs focused on artificial intelligence and infrastructure.

    • SoftBank is best known for its Vision Funds, massive investment vehicles that finance tech startups worldwide, especially in AI, robotics, fintech, and e-commerce.

    • Such large-scale foreign investment may encourage other global companies to invest in the U.S., boosting perception and growth.

  • Nissan-Honda Merger: Potential Impacts on the Auto Industry

    • Nissan ($NSANY) and Honda ($HMC) are reportedly exploring a merger to remain competitive in the growing electric vehicle (EV) market. The combined entity could become the world’s third-largest auto group by vehicle sales behind Toyota and Volkswagen.

    • The merge would allow the companies to pool resources, reduce costs, and reconfigure their EV technology. Potential obstacles could impact the merge due to political scrutiny in Japan, concerns over job cuts, and the need to resolve Nissan’s partnership with Renault.

    • The announcement led to a surge in Nissan's stock price, marking its best trading day in 40 years. Honda shares saw a slight decline. The big question is whether the merger comes too late in the game to align with U.S. market demands and competing with low-cost Chinese EV companies like BYD and NIO.

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Understanding and Using P/E Ratios in Investing

When it comes to evaluating stocks, the Price-to-Earnings (P/E) ratio is one of the most widely used metrics. But what does it really tell us, and how can investors use it effectively to make informed decisions? P/E ratios measure how much investors are willing to pay for each dollar of a company’s earnings. For example, if Apple’s ($AAPL) stock is trading at $248.05 per share. With an earnings per share (EPS) of $6.08, the Price-to-Earnings (P/E) ratio is calculated by dividing the stock price by the EPS price. This means investors are willing to pay approximately $40.80 for every $1 of earnings Apple generates.

  • Types of P/E Ratios:

    • Trailing P/E: Uses the company’s earnings from the past 12 months. Trailing P/E provides a historical perspective.

    • Forward P/E: Projects future earnings based on analysts’ expectations. Forward P/E gives insight into future growth expectations.

    • High P/E Ratio: Often indicates that investors expect high growth in the future. However, it can also signal overvaluation if earnings fail to meet expectations.

    • Low P/E Ratio: Could mean the stock is undervalued or that the company faces challenges. It’s important to dig deeper to understand the reason.

    • An average P/E ratio is roughly in the 20-25 range. Low P/E ratio can be considered anything below 20, and high anything above 25.

  • Using P/E Ratios for Investing:

    • Compare Industries: Different industries have different average P/E ratios. For instance, tech companies often have higher P/E’s due to growth potential, while utilities might have lower P/E’s reflecting steady but slower growth.

    • Look for Growth: A high P/E may still be a good investment if the company’s earnings are growing rapidly. Check metrics like the PEG (Price/Earnings-to-Growth) ratio for a more complete picture.

    • Identify Value: A low P/E might indicate a bargain, but be curious when analyzing these bargains. It could also signal potential problems within the business. Research the company’s fundamentals to ensure the low P/E reflects an opportunity, not a risk.

    • Understand Markets: During bull markets, P/E ratios often expand with investors’ confidence. In bear markets, they can contract as fear takes over. Knowing where we are in the cycle can help you interpret P/E ratios more efficiently.

Remember that P/E ratios aren’t a complete picture of a company. They don’t account for debt levels, cash flow, or one-time earnings events where a company can complety shift the outlook of their forward P/E. Keep in mind that earnings can be manipulated by accounting practices, so always use other metrics like price-to-sales, debt-to-equity, or free cash flow to complement your analysis.

All in all, P/E ratios are a great tool for evaluating stocks. Use it as one part of your investment analysis and consider the bigger picture of a company and other financial metrics. By reviewing and comparing ratios you can learn to spot opportunities and make more informed investment decisions. Investing is as much about understanding the numbers as it is about interpreting the stories behind them. Keep learning, stay curious, and let the P/E ratio guide but not dictate your investment decisions.

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Disclaimer: Graham’s Gazette provides information and resources related to investing, financial topics, and personal growth for educational and entertainment purposes only. The content presented is not intended to be construed as financial advice. Readers are encouraged to conduct their own research and consult with qualified professionals before making any financial decisions. Graham’s Gazette and its creators do not assume any responsibility for the accuracy or completeness of the information provided nor do they guarantee any specific results from such use of information.