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!
Standard Chartered
Today, I’m analysing FTSE ‘Big Five’ bank Standard Chartered (LSE: STAN), the data for which is summarised in the table below.
| Share price 1,286p | Forecast EPS | +/- consensus | P/E* |
|---|---|---|---|
| Consensus | 207 cents | n/a | 10.4 |
| Bull extreme | 246 cents | +19% | 8.8 |
| Bear extreme | 173 cents | -16% | 12.5 |
* EPS at current $ to £ exchange rate of 1.68
As you can see, the most bullish EPS forecast is 19% higher than the consensus, while the most bearish is 16% lower. This 35% spread is narrower than 40% spread of the average blue-chip company.
Furthermore, the fairly tight spread of earnings scenarios that analysts see as plausible for Standard Chartered contrasts even more markedly with other companies in the banking sector: HSBC (46%), Lloyds (54%), Barclays (61%), and Royal Bank of Scotland (118%).
Asia-focused Standard Chartered earns some 90% of its profits from outside Western markets, and was barely touched by the financial crisis of five years ago. There’s no legacy of a government bailout, ongoing massive asset sales, or a fundamental restructuring of the business for Standard Chartered — things that muddy the waters for analysts’ earnings models and lead to a wider range of potential EPS outcomes.
However, this is not to say that Standard Chartered isn’t facing issues of its own. EPS declined 9% last year, in the wake of lower levels of income from transaction banking (international trade finance and suchlike), and higher levels of bad debt in consumer banking.
Concerns about emerging markets generally — and China in particular, where the government is faced with taming excessive credit expansion without suffering a ‘hard landing’ — have weighed on investor sentiment towards Standard Chartered. The shares are more than 20% down from a year ago.
Sure, the analysts as a group have revised down earnings forecasts over the period, but what we have is a situation where Standard Chartered’s consensus P/E is close to a value level of 10, and even the most bearish EPS forecast gives a rating comfortably below the long-term FTSE 100 average of 14. As such, I reckon the shares are looking attractively priced right now for long-term investors.
