Collection: Warren Buffett - #75 | Price to Earnings Ratio (P/E Ratio) Explanation



Thanks for the beautiful — beautiful weekend in Omaha. I’m Mike Asale (PH) from New York City, with a question for Warren and Charlie about what makes a company’s price-earnings ratio move up relative to other companies in its industry. How can we, as investors, find companies, and even industries, that will grow their relative price-earnings ratios as well as their earnings? And thank you for the wonderful weekend and for sharing your brilliance with the shareholders. WARREN BUFFETT

Oh, thank you. AUDIENCE MEMBER

Thank you. (Applause) WARREN BUFFETT

You know, it’s very simple, the price-earnings ratio — relative price-earnings ratios — move up because people expect either the industry or the company’s prospects to be better relative to all other securities than they have been — than their proceeding view. And that can turn out to be justified or otherwise. Absolute price-earnings ratios move up in respect to the earning power — or the prospective earning power of — that is viewed by the investing public of future returns on equity, and also in response to changes in interest rates. And in the recent — well really, ever since 1982, but accentuated in recent years, you’ve had decreasing interest rates pushing up stocks, in aggregate. And you’ve had an increase in corporate profits. Return on equity of American businesses improved dramatically recently. And that also — and people are starting to believe it, so that has pushed up absolute price-earnings ratios. And then within that universe of all stocks, when people get more enthusiastic about a specific business or a specific industry, they will push up the relative P/E ratio for that stock or industry. Charlie, you got anything?


Yes, I think he also asked, how do you forecast these improvements in price-earnings ratios. WARREN BUFFETT

That’s your — that’s your part of the question. (Laughter) CHARLIE MUNGER

Around here I would say that if our predictions have been a little better than other people’s, it’s because we tried to make fewer of them. (Laughter and applause) WARREN BUFFETT

We also try not to do anything difficult, which ties in with that. We really do feel that you get paid just as well — you know, this is not like Olympic diving. In Olympic diving, you know, they have a degree of difficulty factor. And if you can do some very difficult dive, the payoff is greater if you do it well than if you do some very simple dive. That’s not true in investments. You get paid just as well for the most simple dive, as long as you execute it all right. And there’s no reason to try those three-and-a-halfs when you get paid just as well for just diving off the side of the pool and going in cleanly. (Laughter) So we look for one-foot bars to step over rather than seven-foot or eight-foot bars to try and set some Olympic record by jumping over. And it’s very nice, because you get paid just as well for the one-foot bars.

OK, zone 2.


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[YAPSS Takeaway]

You don't have to do something difficult to earn a lot of money in investing.