Valuation analysis should not rely only on whether a PE ratio looks high or low. A low PE may reflect falling earnings risk, while a high PE may be justified by durable growth and strong returns on capital.
Earnings yield provides a benchmark
Earnings yield can be compared with bond yields and cash yields. If it does not compensate for equity risk, a stock may not be cheap even below historical averages.
Margin of safety comes from conservative assumptions
A sound valuation uses conservative assumptions for margins, capex and growth. Attractive returns under lower expectations create better room for error.
