The E Is An Estimate: Valuation Sanity Check
Never call a stock cheap or expensive off a single multiple built on someone's forecast
- Difficulty
- Easy
- Time to result
- ~weeks to results
- Steps
- 5
- Confidence
- 72%
The mechanism is simple arithmetic with a behavioural edge. Price is observable; earnings in a forward P/E are somebody's estimate, so the ratio inherits all the error in that forecast. When estimates prove too high, apparently cheap assets turn out not to be cheap; when estimates prove too low, apparently expensive assets turn out reasonable. Slimmon's worked example is Europe versus the US: Europe has screened cheaper for years, but US earnings, especially in tech, repeatedly beat expectations while European earnings disappointed, so the denominators moved in opposite directions. The practical fix is to watch revisions rather than levels, and to treat a company's first disappointment as the first of a series, because managements drip out bad news and analysts are slow to cut. The tell to distrust most is a note that cuts both the estimate and the price target while declaring the stock has bottomed.
Origin
Extracted from Masters in Business, where Andrew Slimmon described the single-multiple valuation call as the biggest error he sees investors make over time.
Core principles
- 01A P/E is a fact divided by an opinion
- 02Cheap markets stay cheap when the earnings estimate keeps falling
- 03Revisions carry more information than the level of the multiple
- 04Bad news arrives in drips, so one bad quarter usually precedes another
- 05Analysts adjust numbers slowly and reluctantly
How to run it
- 1
Separate the fact from the opinion
Break the multiple into its observable numerator and its forecast denominator, then ask who produced the forecast.
Pro tip Note the dispersion between the highest and lowest analyst estimates as a proxy for confidence.
- 2
Track the revision trend
Plot how the forward estimate has moved over recent months. A rising denominator quietly makes an expensive stock cheaper and vice versa.
Pro tip Direction of revisions beats level of multiple in almost every comparison.
Watch out A falling estimate can make a screen look cheaper every week while the thesis rots.
- 3
Assume bad news comes in series
Treat a disappointing quarter as an early data point rather than the clearing event, because companies rarely disclose everything at once.
Pro tip Wait for evidence of estimate stabilisation before adding.
Watch out One bad quarter usually follows another; buying the first dip is buying into the drip.
- 4
Discount the bottom call attached to a cut
Be sceptical of research that lowers numbers and target price while asserting the stock has already bottomed.
Pro tip Read the direction of the change, not the rating.
- 5
Validate the estimate against company commentary
Compare the consensus forecast with what management actually reports about demand and order books before acting on the multiple.
Pro tip Earnings calls often contradict the prevailing macro narrative first.
In the wild
For years European equities have screened cheaper than US equities on forward P/E. But European earnings repeatedly came in below expectations while US earnings, particularly in tech, came in above. The US denominator rose, lowering its P/E, while Europe's fell, raising its P/E. The apparent discount never converted into returns because the estimate that produced it was wrong.
→ The cheap market stayed cheap; the expensive one was never as expensive as it screened.
With commentary insisting the consumer was exhausted, Slimmon noted a Costco call reporting big-ticket purchases reaccelerating. Rather than accept the macro narrative embedded in estimates, he used company-level commentary as the independent check on the forecast.
→ Company disclosure contradicted the consensus assumption baked into the earnings denominator.
Common mistakes
Buying the cheapest screen line
A low multiple often reflects an estimate that has not yet been cut far enough, which is the definition of a value trap.
Trusting the cut-and-bottom call
Analysts move slowly, so an estimate cut is usually the start of a downgrade cycle rather than the end of one.
Comparing multiples across unlike assets
Different index compositions mean a cross-market P/E gap can be structural rather than an opportunity.
Is it for you?
Best for
Investors who use valuation screens and want to avoid value traps and false expensive-stock rejections.
Not ideal for
Purely systematic strategies that deliberately exclude qualitative judgement about estimate quality.
From the transcript
“is the E is a forward estimate, and it's turned”
“Usually one bad quote as follows another bad quote. I mean,”
From the episode
Andrew Slimmon on Quantitative Factors in Markets
Andrew Slimmon