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The Essential P/E: Understanding the stock market through the price-earnings ratio by Keith Anderson

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Chapter 11. The Long-Term P/E

Why do we take into account earnings from only one year when we try to value a company using the P/E? A year is the amount of time that the Earth takes to go round the Sun, and by law the period over which companies must publish audited accounts. For many companies a year is really not relevant to their business cycle. For most companies the most important effect on their activity is the health of the economy as a whole. They should really have their earnings measured over the whole economic cycle to get a true view of their long-term earnings potential. An economic cycle is generally thought to last 7-8 years on average.

As with many good ideas, this one was first thought of decades ago, and then nothing was ...

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