Questions on Calculated PE & Fair Value computation during shortlisting step.

Q & AQuestions on Calculated PE & Fair Value computation during shortlisting step.
vij asked 4 years ago

1. when doing short listing of stocks, should we also include a filter based on the Fair Value? (i.e. . based on the ROE/Target ROE excluding growth? computation)
   – i am assuming that this is not good as it does not factor in the Growth and hence companies that are good maybe end up being excluded. Or maybe we should do a filter based on Fair value factoring growth?

 2. what is the rationale behind using calculated P/E for short listing of stocks?
    – it looks like a way to get the average earnings? but i why cant we just use average earnings directly? . Sorry of this basic question but this has been lingering in my head for some time.

1 Answers
Peter Lim Staff answered 4 years ago

1. It depends. When you are doing stock screeners, basically you want to filter off to a manageable list for you to find your gems. Screening and left with 1,000 stocks is too many to research one by one, while screening and left with only 1 stock to research is too little. A good number is to screen so that you have about 30 to 100 stocks to research. If i calculate “Fair value” in part of the screening, then i do include growth.
 2. The rationale is of using calculated P/E is it averages out the returns on what the company earns on the company’s equity rather than taking the latest earning (which could be too high, or too low). Yes, you’re right as it seems like average “earnings”. But its different as a bigger equity of the company means that the company should earn more earnings. When we use average earnings, we’re basically not giving any weight on the company’s equities, and would give higher value for company that retains profits compared to another one that pays out as dividends, since the company that pays out dividends would have lesser equity, and thus, lesser profits in the future, generally.