A good article about forward PE

reading through the blogs in the morning, snowball of
good stock bad stock- Finance and Investment through a skeptic's eyes has highlighted a good article for reading Value Restoration Project
Do give it a good read!

Run, Don’t Walk, Away From Forward P/Es
Posted on: 2011/06/20, In: Investment Philosophy, Secular Cycles
One of the most consistent messages I’ve heard throughout my career is that the market is inexpensive or at least “fairly valued” based on next years earnings. We hear it at heights of euphoria and the depths of despair. I don’t recall ever hearing the consensus or even a vocal minority calling the market overvalued based on forward earnings estimates. In fact, we rarely even hear perma-bears cite high P/Es based on forward estimates as the primary cause for concern. Over a decade with low and often significantly negative returns, how can that be?

A Flawed Exercise

What makes market calls based on forward P/Es so dangerous is that the concept makes such good intuitive sense. We know the market’s primary function is to look forward and discount the future back to the present. We know that valuation, as James Montier puts it, is “the closest thing we have to a law of gravity” in finance. We know that earnings, while flawed in many ways (another discussion for another day), are essentially what investors want to pay for. To confuse matters worse, when analyzing an individual company’s stock, skilled investors absolutely would want to forecast forward earnings, make pro-forma adjustments from GAAP and then estimate a fair value based on a P/E multiple of that estimate.

Valuing the market on forward earnings estimates is a flawed exercise which often leads to incorrect assumptions about future market returns. It just doesn’t work very well.the rest of articles