One of the most valuable features of the research tool is its dynamic capabilities. Each time you draw a different timeframe, important calculations such as earnings growth rate (or the growth rate of whatever metric you are drawing) will be calculated relative to the timeframe drawn. Therefore, it’s imperative that you always check the color-coded section of the FAST FACTS boxes to recognize what multiple the various valuation reference lines are being drawn at.
FAST Graphs provide several valuation reference lines. The orange line provides a valuation reference of fair value based on commonly use formulas for valuing a business.
The dark blue line represents a calculation of the normal P/E ratio that the market has typically applied to a company over whatever time frame is graphed.
The dark green shaded area depict a mountain chart of earnings, and the light green shaded area the dividends that are paid out of those earnings.
In simple terms, the normal P/E ratio is a valuation reference line that is placed on the graph relative to any timeframe being graphed. At its core, it is attempting to identify and present the P/E ratio that the market has most commonly applied over a given time period. Therefore, it is designed to present a perspective of what might be considered a reasonable valuation to buy or sell a stock at if the user is comfortable with that level of valuation.
With that said, the normal P/E ratio reference line should not be thought of as a precise valuation representing a perfect time to buy or sell. Instead, it’s important that you realize that whatever the normal P/E ratio calculation is will be presented in the dark blue color coded Fast Facts box to the right of the graph. With this information in hand, it’s important to recognize that that normal PE ratio number applies to every spot relating to the blue line (normal P/E ratio line) on the graph.
Consequently, if for example, the normal P/E ratio calculation is 20, then you can look over the entire graph and know that if the price is below that line the stock is trading at a P/E ratio less than 20, if the price is above the line the stock is trading at a P/E ratio higher than 20 and finally if the price is touching the line the stock is trading at precisely the 20 for that example. Of course, you can point your mouse to the black price line and a pop-up will appear that includes the actual P/E ratio of the company for the time you’re pointing at.
In an attempt to clarify further, the best utilization of the normal P/E ratio line is for the analyzer to evaluate how the market has tended to price or value a given company over whatever timeframe being graphed. Again, it is simply a reference line that is utilized to evaluate how the market has valued a company in relation to how it is currently valuing that same company.
This same logic applies to the orange earnings justified valuation reference line. In some companies, the orange reference line will represent the best proxy for fair value, while in other cases; the normal P/E ratio may represent the best proxy for fair value. It is up to the subscriber to analyze those valuation references and decide for themselves what valuation they are comfortable with when considering a given company.
Is also important to note that the normal P/E ratio calculation is dynamic, and will adapt and adjust to how the market has generally valued a given company over different timeframes. Therefore, I will also submit that this is one reason why it’s important to run multiple timeframes when evaluating a company for purchase or sell.
Additionally, FAST Graphs subscribers are provided the opportunity to draw an additional optional overlay P/E ratio reference line on the graph of their choosing. This simply adds an additional valuation reference line to assist in your evaluation of fair value. Of course, the addition of the overlay P/E ratio option allows the subscriber to pick whatever P/E ratio number they choose. For example, if that normal P/E ratio is 20 and the orange earnings justified fair value calculation is 15, the subscriber can add a third P/E ratio reference line of for example 17.5 that runs or sits in the middle of those two other reference lines. This can provide additional valuation information for the timeframe you are graphing.
But the most important part of what I said, is that these lines should be thought of as references to given valuation levels, and not as absolutes or precise dictums. This is why I refer to FAST Graphs as “a tool to think with.” It presents essential fundamentals at a glance, and reveals a given company’s operating results and relates those results to how the market has typically priced or valued the company. When you know the multiple that the line is being drawn at, you can analyze the price in relation to either of these lines in order to determine how the market has historically valued the business as well as apply a judgement as to what valuation you might be willing to pay as an investor.
Here is an explanation of the normal P/E ratio: “This line and ratio represent the calculated P/E multiple at which the market has tended to value the company over time. Calculated by a trimmed average of annual P/E values for the period shown on the graph with one high and one low removed. This line may not have much meaning if the P/E has tended to change in one direction over time.”
Here is an explanation of the orange line: “Shows the growth and the multiple used for the orange valuation line. GDF low growth, GDF…P/E=G avg. growth, P/E=G high growth. This multiple also represents the P/E ratio of the orange line. When the black price line touches the orange line it is trading at that specific P/E multiple.”
Updated over 1 year ago