Using the Price-to-Earnings Harmonic Mean to Improve Firm Valuation Estimates
Journal of Financial Education
This paper reviews some well-known options to estimate the portfolio average of the price-earnings (P/E) multiple, emphasizing the logic and calculation of the harmonic mean. The harmonic mean is a useful but oftentimes unfamiliar calculation to many students and professionals. The simple arithmetic mean when applied to non-price normalized ratios such as the P/E is biased upwards and cannot be numerically justified, since it is based on equalized earnings. The paper advocates the use of the classic harmonic mean when the need is for an equal-dollar-weighted average and the weighted-average harmonic mean when the need is for an index style market-weighted average. An algorithm that deploys this process has been implemented in the Returnfinder App, which produces Total Return charts that include dividends, and at the aggregated portfolio level.
Agrrawal, Pankaj; Borgman, Richard H.; Clark, John M.; and Strong, Robert A., "Using the Price-to-Earnings Harmonic Mean to Improve Firm Valuation Estimates" (2010). Finance Faculty Scholarship. 2.
pre-print (i.e. pre-refereeing)