The Business of Value Investing.pdf

228 The Business of Value Investing

of this suggests that, over time, the market will value such excep-

tional fundamentals with an increasing multiple, leading to an even

greater value of the business.

In thinking about how much to pay for such growth, the issue

depends on what metric or metrics are most useful to the investor

in determining what to pay for the future growth of a business. The

P/E ratio naturally stands out as the default foundational metric on

which to rely. Just as the name implies, the price to earnings (P/E)

ratio refl ects the current price multiple investors are willing to pay

for a company ’ s earnings. On the whole, the lower the P/E, the

more attractive the investment from a value - oriented perspective.

Of course, a P/E alone doesn ’ t do the trick.

First, the quality of earnings of a business should be consid-

ered. For example, a company like Proctor & Gamble, which has

historically traded for around 12 to 18 times earnings, should not

be immediately dismissed compared to a similar company that

might be trading for 7 times earnings. Proctor & Gamble has dec-

ades of earnings history that demonstrate the quality of earnings

to be as dependable as any investor might wish for. The company

has also increased dividends for as many years as you might wish

to go back. So, naturally, the quality and dependability of the

growth over a period of years should weigh heavily on an investor ’ s

consideration with regard to the appropriate multiple of earn-

ings to pay. The characteristics of an investment operation would

certainly justify paying 12 times earnings for a Proctor & Gamble

type business that has grown sales and profi ts for decades through

various economic cycles rather than paying 7 times earnings for

a business that could suffer a substantial decline in profi ts or

even an operating loss during any abrupt change in the business

environment.

Naturally, a value investor would employ painstaking effort in

both trying to pay the least expensive price (i.e., low P/E) coupled

with the greatest potential upside for increased growth. Proctor &

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