Practical Applications of The Price/Earnings Ratio, Growth, and Interest Rates: The Smartest BET

Practical Applications Summary In The Price/Earnings Ratio, Growth, and Interest Rates: The Smartest BET, from the September 2019 edition of The Journal of Portfolio Management, Preston Estep of Battenkill LLC proposes a more elastic and encompassing break-even time (BET) metric as an alternative to the price/earnings (P/E) ratio for measuring investment value. The author defines BET as the number of years it takes for a company’s earnings to add up to its current stock price. Unlike the P/E ratio, his BET formula explicitly estimates future growth and discounted future earnings. According to the author, the resulting BET metric is superior to P/E and P/E-to-growth rate (PEG) ratios, in that BET allows for valuation comparisons of stocks with profoundly different growth rates and investor expectations. In advocating for his BET, the author calls into question some of the conventional wisdom about the relationship between yields and stock returns. His empirical analysis finds mostly random correlations in the relationships between valuation measures, including BET, and observed stock returns. But his findings support the need for stock valuations to include an assessment of a firm’s growth prospects—something he asserts the BET metric can readily do.