Long term PE ratio

A long term PE ratio is the share price as the multiple of the average earnings per share over several previous years. It is a more cautious measure for value investors than a simple historical PE, because it dilutes the effect of any recent positive fluctuation.

The long term PE is also a little less susceptible to the effects of creative accounting, because it can dilute the effects of some, short term, methods of manipulating the accounts.

The calculation of the long term PE is fairly simple: the price divided by the mean of several past years' earnings.

The same adjustments can be made to long term PE as for other types of PE ratio, however, doing many of these adjustments over several years is proportionately more work than doing it for a single year. Furthermore, it may be less necessary to make the adjustment because any distortions are likely to be diluted over a long period.

As atypical spurts of high earnings, and distortions of the accounts may last several years, the long term PE ratio is most likely to be useful when the earnings are taken over a fairly long period: eight to ten years is common.

The long term PE ratio is very much a value investor's measure. It picks out cheap shares with stable earnings. It is unsurprising that it was much favoured Benjamin Graham. Recent research suggests that it is an effective way of picking value stocks, and closely linked to possible explanations of the value effect.

The long term PE is very similar to the cyclically adjusted PE, and they can be synonymous if the simplest calculation of the latter is used. Cyclically adjusted PE is often used to look at the valuation of the market, as well as shares.

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