Why The P/E Ratio Is USELESS (sometimes)

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The pe ratio is one of the most widely used valuation metrics. However, the pe ratio is all but useless until you understand how operating leverage and economies of scale work.

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When I was a new investor I focused exclusively on the p/e ratio when I was analyzing stocks. That single decision caused me to pass on buying some of the greatest growth stocks of the last 20 years. Only later did I learn about two key business attribute that makes the p/e ratio all but useless: operating leverage & economies of scale.

What is operating leverage? Operating leverage is when a company's revenue rises but its fixed costs stay constant, which allows a company's profits to grow MUCH FASTER than revenue.

Economies of scale is when a company is able to lower its unit costs and increase its margins thanks to increased buying power.

It's only after you fully understand these two basic business concepts that the PE ratio can be useful.

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0:00 Intro
0:35 Operating Leverage
1:34 Coffee Stand Example
5:23 Tesla Example
8:06 Growth & Valuation Metrics
8:34 Amazon Example

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