Why cash flow yield beats PER

Investors spend a lot of time worrying about reported earnings. Perhaps that’s because the valuation shortcut that derives from it—the price-to-earnings ratio (PER)—gets a great deal of attention. Too much attention, in fact. What’s often misunderstood is that reported earnings and intrinsic value—the underlying value of a business—really have little to do with each other. Accountants make choices about how to report earnings while intrinsic value requires an estimation of future free cash flows, not profits. No lesser source than Berkshire Hathaway’s Owner’s Manual states: ‘Intrinsic value can be defined simply: It is the discounted value of the cash...

Investors spend a lot of time worrying about reported earnings. Perhaps that’s because the valuation shortcut that derives from it—the price-to-earnings ratio (PER)—gets a great deal of attention. Too much attention, in fact.

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