The forward price-to-earnings (P/E) ratio — share price divided by the consensus of analysts’ forecasts for earnings per share (EPS) — is probably the single most popular valuation measure used by investors.
However, it can pay to look beyond the consensus to the spread between the most bullish and bearish EPS forecasts. The table below shows the effect of different spreads on a company with a consensus P/E of 14 (the long-term FTSE 100 average).
| EPS spread | Bull extreme P/E |
Consensus P/E |
Bear extreme P/E |
|---|---|---|---|
| Narrow 10% (+ and – 5%) | 13.3 | 14.0 | 14.7 |
| Average 40% (+ and – 20%) | 11.7 | 14.0 | 17.5 |
| Wide 100% (+ and – 50%) | 9.3 | 14.0 | 28.0 |
In the case of the narrow spread, you probably wouldn’t be too unhappy if the bear analyst’s EPS forecast panned out, and you found you’d bought on a P/E of 14.7, rather than the consensus 14. But how about if the bear analyst was on the button in the case of the wide spread? Not so happy, I’d imagine!
Should you invest £1,000 in BP right now?
When investing expert Mark Rogers has a stock tip, it can pay to listen. After all, the flagship Motley Fool Share Advisor newsletter he has run for nearly a decade has provided thousands of paying members with top stock recommendations from the UK and US markets. And right now, Mark thinks there are 6 standout stocks that investors should consider buying. Want to see if BP made the list?
BT Group
Today, I’m analysing Footsie telecoms firm BT Group (LSE: BT-A) (NYSE: BT.US). The data for the company’s financial year ending March 2015 is summarised in the table below.
| Share price 388p | Forecast EPS |
+/- consensus |
P/E |
|---|---|---|---|
| Consensus | 28.7p | n/a | 13.5 |
| Bull extreme | 33.9p | +18% | 11.4 |
| Bear extreme | 20.0p | -30% | 19.4 |
As you can see, with the most bullish EPS forecast 18% higher than the consensus, and the most bearish 30% lower, BT’s 48% spread is somewhat wider than the 40% spread of the average blue-chip company.
BT’s recent bold move into pay-TV is probably one reason why analysts see a relatively wide range of plausible earnings scenarios. Changes in a business tend to cloud earnings visibility in the short term. For example, the game-changing sale by Vodafone of its stake in US phones firm Verizon Wireless is an extreme case: the EPS spread for Vodafone, which is now on the acquisition trail, is a super-wide 128%.
There has been good momentum within BT’s business since the financial crisis of 2008/9, reflected in a 345% rise in the shares over five years, 100% over three years, and 28% over one year.
In annual results released earlier this month BT said:
“We have made strong progress this year. Underlying revenue, adjusted profit before tax and normalised free cash flow have all grown and beaten market expectations”.
It’s no real surprise, then, that the market is rating BT close to — although still just on the value side — of the FTSE 100 long-term average P/E of 14, based on the analyst consensus EPS forecast. The bull extreme brings the P/E down to 11.4, but at the other end of the spectrum the P/E rises to 19.4.
