Sharing Common Issues in P/E Ratio Calculation – Avoid the “Carving on Gunwale” Fallacy

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Issue 1: Ignoring the Balance Sheet and Overlooking “Core P/E”

Typical Trap: For large investment holding companies like Tencent, if you only look at total market cap/net profit, the P/E might fluctuate around 20x. However, this figure includes trillions in investment portfolio gains, which generate independent value fluctuations. Investors are actually more concerned with the performance of its core businesses (advertising, gaming, fintech, etc.).

Corrective Perspective (Core P/E):
● Formula: Core P/E = (Total Market Cap – Fair Value of Investment Assets) / (Operating Business Net Profit)
● Tencent Example: Assuming Tencent’s current market cap is HKD 4.71 trillion, with investment assets valued at HKD 1 trillion, and 2024 net profit of HKD 166 billion, the core P/E = (4.71 trillion – 1 trillion) / 203.5 billion ≈ 18.5x. This is significantly lower than the surface-level P/E, better reflecting the actual valuation of its core business.

Issue 2: “Carving on Gunwale” – Ignoring Growth Momentum

Typical Trap: When Nvidia’s P/E hit 60x, many investors called it “overvalued” and stayed观望. In absolute terms, it was 2-3x higher than typical blue chips. The problem? Growth is the engine of value. A company growing at 5% annually and one growing at 100% cannot be judged by the same P/E.

Corrective Perspective (PEG is Key):
● Formula: PEG = P/E / Expected Annual Growth Rate (in percentage, not decimal)
● Nvidia Example: With a P/E of 60 and expected annual growth of 100%, PEG = 60/100 = 0.6. A PEG around 1 is generally considered fair. A PEG below 1 suggests that even a high P/E may hide opportunities, as rapid growth can quickly absorb current valuations.

Issue 3: Ignoring Growth Deceleration – Falling into the “Low P/E Trap”

This is the inverse of Issue 2, emphasizing the need to consider growth alongside P/E.

Issue 4: Overreliance on Static P/E, Ignoring Dynamic Metrics

Static P/E (LYR) is based on historical profits and fails to reflect future changes. For high-growth or转型 companies, relying solely on static metrics leads to severe valuation distortions.

Solutions:
● Trailing P/E (TTM): Uses the last four quarters’ profits (e.g., Yili Group’s 2024 TTM P/E = 12x vs. static P/E = 13.6x).
● Forward P/E: Based on analyst consensus forecasts (e.g., broker projections for CATL’s 2025 earnings).

Issue 5: Valuing Companies in Transition/Second Curve/Multi-Business Models (e.g., Tesla, Pinduoduo, Alibaba)

From a current profit perspective, Tesla’s 200x P/E seems unreasonable. However, Tesla is transitioning from selling cars to selling FSD, then to services. Similarly, Pinduoduo is expanding into TEMU, and Alibaba operates multiple businesses. Traditional P/E fails here because current profits don’t reflect new ventures’ potential, while new ventures lack mature financial data.

Systematic Solutions for Transitional/Multi-Business Companies:

I. Valuation Challenges for Transitional/Multi-Business Firms

1. Mismatched Business Stages

● Mature businesses (e.g., Tesla’s auto manufacturing): Use P/E or EV/EBITDA (e.g., traditional automakers at 10-15x P/E).
● Growth businesses (e.g., FSD, TEMU): Use P/S, user value (ARPU), or discounted cash flow (DCF).

2. Synergies and Risk Overlaps

● New ventures may disrupt core businesses (e.g., Tesla shifting from “automaker” to “mobility service provider”).
● For loosely related multi-business firms (e.g., Alibaba’s e-commerce + cloud + payments), avoid simple summation; value separately and deduct management costs.

II. Mainstream Valuation Methodologies

1. Sum-of-the-Parts (SOTP) – The Gold Standard for Multi-Business Firms

Steps:
① Business Segmentation: Split into independent units (e.g., Tesla: auto manufacturing, FSD software, energy storage, Robotaxi).
② Unit Valuation:

Mature businesses: P/E or EV/EBITDA.
Growth businesses: P/S or P/user (e.g., TEMU, benchmarked against cross-border e-commerce P/S of 1.5-3x).
Tech/IP-driven businesses: Option pricing models (e.g., FSD, based on patent portfolio and adoption rates).
③ Aggregation Adjustments:
Sum unit values, deduct HQ costs (typically 5-10%).
Add synergy premiums (e.g., Alibaba’s e-commerce and cloud cross-selling, 10-20% premium).

Table: Alibaba SOTP Valuation Example (Hypothetical Data)

Business Unit	Valuation Method	Key Parameters	Value Contribution ($B)
Core E-commerce	PE 15x	2025E Net Profit $20B	300
Alibaba Cloud	P/S 5x	2025E Revenue $15B	75
Int’l E-commerce (TEMU-like)	P/S 2x	2025E Revenue $8B	16
Local Services	EV/EBITDA 18x	2025E EBITDA $2B	36
Subtotal			427
Adjustments	-10% HQ Costs	+15% Synergy Premium	Final Value: $440B

In summary, P/E calculations should be dynamic and incorporate multiple factors.

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