ADVISOR WATCHLIST
as earnings per share ( EPS ). The higher the PER number the more you are paying for the business and vice-versa .
Now of these two inputs , the share price is a given . It is set by the stock market and as proponents of the efficient market hypothesis would argue it incorporates all the important and available information known . We would beg to differ .
No single ratio can tell you all you need to know about a stock , and in fact the EPS calculation is not as straightforward , involving all manner of financial gymnastics to get to the bottom line . The accountants have engineered a job for life , ably supported by the auditing community who make sure everything is in order , or qualified .
What makes the PER comparison difficult is the very thing that should make it easy . That is , the lack of consistency in calculating the most important input , net profits . What gets included ( the type of expenses ), what is missing ( outlays that are capitalised and not expensed ), what is applied differently ( rate of depreciation write-off against assets ) and what is random ( one off gains and losses ), are the very things that make this output , and what investors are relying on , such a hit and miss process .
To deduce that a portfolio with a lower average PER carries less risk and therefore by definition , greater potential upside , is like comparing apples with oranges . The obvious fact that they are both fruits is where any similarity ends .
The PER itself is reflective of what an investor is prepared to pay for a business compared to its earnings . Generally , it captures either historical or past earnings and some expectation of future profits . A low multiple is often attributed to lower growth businesses . Conversely a high PER is associated with a higher earnings profile .
Obviously , a lower ratio is preferred , being a quicker period for the investment outlaid to be recouped , but in truth that is where the assumptions stop , and the realities start .
Unlike an asset class , like a toll road , that has some sort of revenue predictability ( at least we thought it did until COVID came along ), most businesses are dynamic . Regulation , competition , new markets , loss of clients and economic impacts , all go into the mix to define how well a business may perform .
So , what are investors to make of a PER ? In short , it is crude and hides all manner of business sins . The absolute number may indicate the level of risk one is exposed to , but in truth investing is not that simple . As Telstra shareholders have unfortunately experienced , the long-term success and sustainability of a business goes well beyond a company ’ s PER score . There is more that goes into the mix of what makes a good business , as well as the risks at play , than just a raw number .
Top of the list is the business team , which we loosely term management . The focus however extends beyond the chief executive officer ( CEO ) and finance personnel . While the CEO is critical in setting the strategy and direction , the best companies are those with a collective purpose from the top down . There needs to be buy in from the board all the way to the office junior . It is this very buy in , what we call culture that is nurtured over time .
Culturally aligned businesses have that special x-factor and are often seen in founder-led organisations . They have a clearly focused purpose , a true north star pursuit , involving a strategic intent . Importantly , success is measured against internal objectives , rather than market obsessed yearly metrics .
A culturally aligned team in pursuit of its business objectives often displays common traits , including :
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