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I would like to share with you on my thoughts on stock valuations.

GuruFocus (GF) Value: a Better Valuation Measure vs. PE

By Charlie Tian

Notable points

PE (Price-to-Earnings) ratio is widely used but can be misleading for cyclical industries and not considering the growth aspects of the businesses
GF Value framework takes into account of earnings growth and volatility to better measure stock valuation
An example of Microsoft of PE (~36) yet considered fair value after taking into earnings growth and business predictability

The Limitations of the Price-to-Earnings (P/E) Ratio

The price-to-earnings (P/E) ratio is one of the most commonly used tools for valuing stocks. It’s simple to calculate, easy to compare across companies, and widely available. Yet, its popularity often hides several key flaws that can mislead investors - particularly in today’s fast-changing markets.

1. Misleads in Cyclical Industries

For companies tied to commodity or economic cycles, the P/E ratio can invert logic. These firms often appear cheap when earnings are at their peak and expensive when profits are depressed - exactly the opposite of what investors should infer.

2. Earnings Are Often Volatile

A single year’s earnings can be distorted by one-off items such as asset write-downs, tax adjustments, or extraordinary gains—making the P/E ratio fluctuate dramatically. Relying on that snapshot can give a false impression of a company’s true performance.

3. Overlooks Growth Potential

The P/E ratio doesn’t account for future growth. As Peter Lynch famously noted, “Because of compounding, a 20 percent grower with a P/E of 20x is a better investment than a 10 percent grower selling at a P/E of 10x.” In other words, higher multiples can be justified by stronger, sustained growth.

Because of these limitations, relying on P/E alone can lead to value traps or cause investors to overlook genuine opportunities.

Key Strengths of the GuruFocus(GF) Value Chart: An Example

GuruFocus developed the proprietary GF Value framework to offer a more complete picture of a company’s valuation. Rather than relying on a single metric, it integrates multiple key factors. It identifies key fundamentals, not just earnings level, that better reflects the stock price.

By integrating these factors, the GF Value model produces a fair value line and valuation bands that show a stock’s current valuation - ranging from significantly undervalued to fairly valued, to significantly overvalued.

Example: Microsoft

At first glance, Microsoft often trades at a high P/E ratio of 36 and looks overpriced. But the GF Value chart tells a clearer story.

Date: 11/10/2025. Source: GuruFocus.com

The GF Value framework considers several key factors:

Microsoft’s consistent revenue and earnings growth
Its stable profitability and limited sensitivity to economic cycles
The historical relationship between its stock performance and business fundamentals

Taking these factors into account, Microsoft appears to be fairly valued under the GF Value model.Rather than focusing on just one year, GF Value aligns valuation with consistent fundamentals, quality, and long-term growth.

Conclusion

The P/E ratio serves as a useful starting point for valuation, but by itself, it fails to capture key drivers such as growth potential, competitive strength, and business consistency. The GuruFocus (GF) Value Chart delivers a more comprehensive, data-driven analysis by blending historical trends with forward-looking fundamentals.

In a market where oversimplified metrics can lead to costly errors, GF Value provides investors with a clearer and more intelligent framework for identifying mispriced stocks—helping them avoid overpaying for average businesses while recognizing opportunities in truly high-quality companies.

About: Charlie Tian, Ph.D. is the founder and Chief Executive Officer and portfolio manager of GuruFocus Investments, LLC, an SEC-registered investment management firm.