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P/E ratio

Price to earnings is an important ratio to look at for any share. normally share price = p/E * EPS( earnings per share= net profit/total number of shares). but think invert like Charlie Munger that where can we go wrong to look at only P/e for valuation.

     The first point is Net profit which is easy to manipulate  therefore if management is not ethical then they will manipulate their profit by anything. for example they will reduce their share capital (share dilution) or take much debt for increasing profits." check share capital for last ten years and borrowing, ROE"

      Secondly, when any company can benefit from any situation which is not for the long term but one quarter or year only. for example, oxygen companies benefited from a pandemic then suddenly earnings will go up and p/e look attractive or another reason behind that sector will not do well then value migration happens. for example, Castrol is a good company but when EV comes Castrol will not play an important role. therefore, p/e looks attractive. normally people tell this as "value traps". " Check last ten years of revenue if sudden increase then go through management discussion"

     Thirdly, If free cash flow( cash from the operation - used for CAPEX (capital expenditure)) is used for driving the earnings then high p/e stock will do better. for example, the p/e of Amazon is 300 for many more years however stock goes 100x+. In simple terms, free cash flow means your savings account balance which is used to buy things rather than taking a loan(debt) from a bank or father(equity).  "check capex part, marketing or operating efficiencies from where companies will generate free cash flow"

           Overall, we can not depend on only one valuation matrix rather than we can think about others also but p/e is a good starting point to value any company

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