Book Review

Who needs a book on the P/E?
In recent decades the P/E has been the most important and best known investment ratio, but what does it actually mean? Apart from the share price, it is the only investment statistic that is published in print every day. Every share quoted in London has its P/E printed daily in the Companies section of the Financial Times. The P/E also has a strong intuitive meaning: it tells you how many years? worth of future earnings you are paying in order to buy the share now.

One might ask why there hasn?t been a book before on the P/E.
On the other hand, if you are a fund manager, the P/E or something based on it will be just one of the battery of ratios you use. You will have a filter of many different investment ratios that all of your investment universe must pass. The computer does the filtering for you, and presents you with a list of all the stocks that are interesting enough to be worth investigating further. The P/E is an integral but probably minor part of that process, and you would no more expect a book on the P/E than on ROCE or EBITDA.

While the value to investors of being familiar with this widely used statistic is clear, professionals in financial markets may find it a more surprising subject, possibly never having stopped to think how or why it is calculated that way. Such professionals may well be surprised by how easily the P/E could be improved if things were done slightly differently.

Who is this book for?
The Essential P/E is primarily aimed at investors who already know something about investing in shares, but is also suitable for market professionals and academics. Quite simply, readers should already know what a price-earnings ratio (P/E) is.
If you are a private investor, rest assured that this book assumes no prior knowledge of any particular accounting or finance terms. Everything covered is defined at the time. For more detail, many terms, in particular accounting terms, are explained in the Glossary at the back. There are however many new ideas presented, and beyond Part I even seasoned stock market investors will need to think hard.

This book is also suitable for investment analysts, fund managers or finance academics. If you have a finance MSc or MBA then you may find some of the explanations over-simplified, but you will also learn much that is new. Using the P/E to get the best investment results is far from a simple task once you get into the details, and you should also find much of interest here.

What does the book cover?
The book starts with the basics: the fundamentals of share prices and how earnings and P/Es are calculated in the UK. Author Keith Anderson then looks at the value premium, which is the whole basis of using the P/E as an investment tool: low P/E shares, on average, outperform the market. He then covers some of the models that believers in efficient markets have come up with to try to explain this inconvenient fact, and why those who believe in pervasive mispricing remain unconvinced. This group of value investors includes such illustrious figures as Warren Buffett.

The second half of the book gets into the details of the P/E: developments that have tried to improve it, and how some famous value investors have combined it with other measures. The P/E can be made into a powerful tool. But as with most powerful tools it can run amok if you don?t control it properly, check what it is telling you by looking at other statistics, and apply a liberal amount of common sense.

Overall The Essential P/E is a practical and informative guide to this enigmatic stock valuation tool. Carefully constructed and well written, this book is a worthwhile read for anyone wanting to boost his or her stock returns.