Message Font: Serif | Sans-Serif
No. of Recommendations: 3
Hi Carpian

The two calculations estimate two different things. The PE fraction method provides a simple average, weighted by price, across a population of stocks. DTM's method is the overall PE of the portfolio. Your PE 10 stock contributes more because it contributes more (i.e., 2/3) of the earnings of the portfolio.

The "simple average, weighted by price" is about the worst way to estimate the PE of a basked of equities to determine if it is over or under priced.

Take a basket of 20 stocks of equal value in a portfolio. Nineteen (19) have a PE of 10 and one (1) has a PE of 1000. The simple average approach provides an overall PE of 59.5 while the total price / total earnings has an overall PE of 10.52. Even replacing the PE of 1000 with the arbitrary PE value of 200 still gives an overall PE of 10.5.

Which do you think better reflects the "price to earnings" of the basket of equities? Even using the mode (PE of 10 in this case) is a better approach. All of which shows that a highly valued market using a simple average weighted by market capitalization can mask a considerable number of low priced equities.

In my view the simple average weighted by market capitalization / portfolio value is a nearly meaningless statistic.


Print the post  


When Life Gives You Lemons
We all have had hardships and made poor decisions. The important thing is how we respond and grow. Read the story of a Fool who started from nothing, and looks to gain everything.
Contact Us
Contact Customer Service and other Fool departments here.
Work for Fools?
Winner of the Washingtonian great places to work, and Glassdoor #1 Company to Work For 2015! Have access to all of TMF's online and email products for FREE, and be paid for your contributions to TMF! Click the link and start your Fool career.