Don’t Pay Attention to Recent Earnings

The most common and effective way to value almost anything that earns money each year is to take its earnings per year and to multiply that figure by a multiplier. This valuation process is commonly used by stock investors to determine the earnings they’re getting for each dollar they invest. While this method is pretty reliable, the application that many investors utilize can be used to make blatantly overblown future projections as to the magnitude of earnings. Financial information sites like to give you these ratios and multipliers based on the most recent financial reports. One of these is the PE ratio, which takes into account the earnings of the current year. 

A better, but not perfect alternative, is to look at the average earnings over time. The time period to average the earnings should be at least a few years for developed companies but not too long ago that the company was vastly different. After taking the average earnings per share, compare it to the current price to determine a more accurate PE ratio. 

Stock analysts could do well to buy when a stock recently had a hit to their earnings as a result of fixable issues as people tend to extrapolate events that have no business being extrapolated. Likewise, analysts would do well to sell when a very good year exaggerates the price to greedy proportions.