A reader once asked me about software PE ratio, when I discussed the valuation of the software industry on section 3-2 of my book “The Rules of Super Growth Stocks Investing.” mentioned that the P/E ratio of software companies is about 20 times; I also said that the P/E ratio of software companies is about twice that of hardware companies. What is my basis?
P/E ratio is a dynamic variable
Please note the P/E ratio is a fluctuating number at any time. For example, the times, the bull market or the bear market, and the industry will have a significant impact on the P/E (price to earnings) ratio. However, there is still a certain consensus in the capital market. This consensus is mainly determined by the industry in which the company is located. Leading manufacturers in the industry usually enjoy a higher P/E ratio than other followers. Therefore, investors can first find the industry in which individual stocks are located, and then find the leaders in that industry.
Based on competitiveness, market share, and their respective operating conditions, they can estimate a reasonable P/E ratio that should be roughly expected. Twenty times should be an approximate P/E ratio of the software industry, such as Adobe (ticker: ADBE), Microsoft (ticker: MSFT), Alphabet (ticker:s: GOOGL and GOOG), Facebook ( ticker: META) and other mature software companies with surpluses rarely have a P/E ratio below 20, and will only be higher than this (except during the crash). Like the current bull market, almost all of these companies are above 35.
Reference basis
Reference basis ─ ─ Frankly speaking, this is my experience value; but there are also places to refer to. Wall Street people and institutional investors will subscribe to Bloomberg Terminal for about $40,000 a year. One of its main functions is to instantly list various industries and the P/E ratio of individual stocks in this industry. NYU Stern School also regularly releases information on this aspect (P/E ratio of each industry), but they are also generated based on tools such as Bloomberg Terminal. The difference between the two is that the academy’s use is not so immediate, because they are mainly used for teaching and research do not need real-time information in theory.
Hardware might not lower than software
Even the P/E ratio or valuation of listed hardware companies is not necessarily lower than that of listed software companies. For example, those listed on section 3-2 in the book “The Rules of Super Growth Stocks Investing” are no worse than well-known software giants. Sometimes it far surpasses these software giants. “How does nVidia make money, Nvidia is changing the gaming rules” is a fresh example that comes at hand, and there are many such examples, especially many fabless semiconductor giants.
General speaking, hardware device makers like laptop brands Hewlett-Packard (ticker: HPQ) and Dell (ticker: DELL) will have lower P/E ratio, but Apple (ticker: AAPL), again, is an exception. So it depends on which type of hardware company. How competitive is the company itself? How is the market occupied? Are there prospects? What we are talking about is a principle and experience that can be applied to most situations and is in line with most companies. Don’t think there is a formula to calculate company P/E ratio.
Valuation is complicate
In short, valuation is a complex subject, which is not only subjective, but also involves many related factors; this is what I have repeatedly quoted many successful investment masters in the book ───Stock investment is an art, not a science; The reason is here, because it is impossible to have a valuation formula applicable to the fair value of all complicated.
P/E Ratio and Query Tool
Take December 2022 as an example, about half of the companies have a price-to-earnings ratio of less than 14 times, and even a price-to-earnings ratio of less than 8 times is not uncommon. You may be curious about the historical data of the price-to-earnings ratio of U.S. stocks. For this part, please refer to the explanation in my other article “S&P 500 P/E ratio has been rising in the past century, S&P 500 PE Ratio and Average Querier“.
Related articles
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- “Vertical software is expensive, but worth the investment“
- “Software PE ratio is about twice that of hardware. What is the basis?“
- “S&P 500 P/E ratio has been rising in the past century, S&P 500 PE Ratio and Average Querier“
- “How does nVidia make money, Nvidia is changing the gaming rules“
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