Definition

The Mean Price to Earnings (PE) Ratio is a valuation metric that represents the average PE ratio of a group of companies or an entire market. It is used to assess whether a stock or market is overvalued or undervalued compared to its historical average or to other companies in the same sector.

Formula

Mean PE Ratio = (Sum of PE Ratios of Selected Companies) / (Number of Companies)

How to use the valuation method

To use the Mean PE Ratio for valuation, compare the PE ratio of a specific company to the mean PE ratio of its industry or market. If a company's PE ratio is significantly higher than the mean, it may be overvalued, while a lower PE ratio may indicate undervaluation. This comparison helps investors make informed decisions about buying or selling stocks.

Which industries it work best in

The Mean PE Ratio works best in stable and mature industries where earnings are relatively predictable, such as utilities, consumer staples, and industrials. These industries typically have consistent earnings, making the PE ratio a reliable measure of valuation.

Which industries it does not apply to and why

The Mean PE Ratio is less applicable to industries with high volatility or rapidly changing earnings, such as technology or biotechnology. In these sectors, earnings can be unpredictable, and companies may have negative earnings, making the PE ratio less meaningful or even unusable.

Summary

The Mean PE Ratio is a useful tool for evaluating whether a stock or market is overvalued or undervalued by comparing it to the average PE ratio of a group of companies or the market. It is most effective in stable industries with predictable earnings but may not be suitable for volatile sectors with inconsistent earnings.