Market valuations are calculated in terms of multiples of price to earnings (P-E) ratio, which basically indicates the price you are willing to pay for one unit of earnings. But while the P-E of one stock measures how much the market is willing to pay for a constant growth represented by the historical earnings or for the future growth represented by estimated forward earnings, the P-E of a portfolio can’t be interpreted in the same manner. Portfolio P-E may or may not be directly linked to net asset value of a fund the way stock price is linked to P-E.
HIGH Versus Low portfolio P-E
When you look at a particular stock, the trailing P-E ratio will show what the market is willing to pay for current earnings of a company. This can be compared with the forward P-E, which is essentially current price divided by the estimated future annual earnings. If the future earnings are expected to grow at a rate faster than the previous few years, then the forward P-E is likely to be lower than the trailing P-E (given that price considered is the same), and vice versa. This can be compared with the trailing and forward P-Es of a competitor with similar attributes. Ideally, a stock with lower P-E and higher growth should be favoured. But for a portfolio, the P-E ratio is the weighted average P-E for each stock in the portfolio. A portfolio can have stocks with both high and low P-E ratios, however it may not be accurate to compare these as they could belong to different sectors. For example, in case of cyclical sectors such as metals, mining and cement, P-E ratios are usually low.
