The Investment Pie: Price = P/E x EPS x Quantity - 2025-10-28

🍎 The Investment Pie: Price = P/E x EPS x Quantity

Imagine owning a tiny piece of a real business, like a local bakery or a popular toy store. That tiny piece is called a share.

The formula tells us the total value of your shares price is made up of three things:

1. The Business Itself (💰 Earnings Per Share - EPS)

Think of EPS (Earnings Per Share) as the slice of profit the company makes just for your one share.

• What it is: The EPS tells you how much money the business actually earned from selling its products or services. It shows the quality and profitability of the business itself.
• The Warren Buffett Lesson: I look for businesses that are like a moat-protected castle . They have something special that keeps competitors away—maybe a famous brand name, the lowest production cost, or something everyone needs. We want a company that consistently earns a lot of money and has a good chance of earning even more next year.
• Analogy: If you owned a lemonade stand, the EPS is how much profit you make on each cup of lemonade sold. We want the stand with the best recipe and the best location that people will keep coming back to.

2. The Market's Mood (🎭 Price-to-Earnings Ratio - P/E)

The P/E ratio is like the price tag the market puts on that $1 of profit. It tells us how excited or scared people are about the business.

• What it is: The P/E ratio is a multiple. A P/E of 20 means the market is willing to pay $20 for every $1 the company earns. This part is largely driven by the market's emotions, hopes, and fears.
• High P/E (High Hopes): People are very excited and think the earnings will grow fast. They pay a lot now for future growth.
• Low P/E (Low Hopes): People are worried or uninterested. They don't want to pay much for the company's current earnings.
• The Warren Buffett Lesson: I believe you should buy a dollar for 50 cents. The best time to buy is when the market's emotions are low (a lower P/E), but the business itself (the EPS) is still strong. “Be fearful when others are greedy and greedy when others are fearful.” A high price (high P/E) doesn't always mean a good investment; it can just mean a lot of people are excited right now.

3. Your Ownership (👤 Quantity)

This is the simplest, but most powerful part: How many shares you own.

• What it is: This is the piece of the pie you own. If the business earns more (higher EPS) and the market values it more (higher P/E), the more shares you own, the more your total investment is worth.
• The Warren Buffett Lesson: The key is to own a piece of a great business and then hold it for a long, long time. I often say, “Our favorite holding period is forever.” You want the power of compounding . This is where your earnings start earning more earnings, and so on, making your Quantity more and more valuable over many years. If you own 0, nothing will improve in the end! For a good company if the P/E is low, it is an opportunity for us to accumulate more!

Let’s combine P/E ratio with EPS, consider a stock with a high P/E ratio of 20 times earnings. While this may seem expensive, if the company can grow its profit by 30% each year, the P/E relative to your initial cost will drop significantly. If you hold the stock for 13 years, the future earnings will make your effective P/E drop to just 0.86 (refer to table below)

Year	Profit	$ Market price	P/E
1	1.00	20	20.00
2	1.30	20	15.38
3	1.69	20	11.83
4	2.20	20	9.10
5	2.86	20	7.00
6	3.71	20	5.39
7	4.83	20	4.14
8	6.27	20	3.19
9	8.16	20	2.45
10	10.60	20	1.89
11	13.79	20	1.45
12	17.92	20	1.12
13	23.30	20	0.86

This calculation means that your initial $20 paid per share will be earning $23.30 per share in the 13th year!

Now, projecting the potential market price based on that EPS:

• If the market still values the company at 20 times earnings, the price will be: $23.30 x 20 = $466.00.
• If the market is more optimistic and gives it 30 times earnings, the price could be: $23.30 x 30 = $699.00.
• However, if the market becomes pessimistic and assigns a lower multiple like 5 times earnings, the price will be: $23.30 x 5 = $116.50.

Therefore, the most important thing to focus on is, as repeated three times: Profit of the business! Profit of the business! Profit of the business! If the EPS is high, the lower P/E still can give us satisfying returns!

🏆 Summary: The Value Investor's Focus

As a value investor, we pay attention to all three parts, but we focus most on the EPS (the business) and manage the P/E (the price):

1. Find a Great Business (High EPS): Look for simple businesses that you can understand and that have a strong competitive advantage (a moat).

2. Buy at a Good Price (Low P/E):
   Be patient. Wait for the market to be worried or emotional, and buy when the price is low compared to the company's real value. However, if we are confident the company will have high EPS in the future with the great business - 20 times of the earnings still gives us satisfying returns!
   

3. Hold On (High Quantity, Long Time): Let the power of compounding work its magic over decades.

This formula teaches us two main things: The EPS (Earnings Per Share) originates from the company's fundamental business, which makes it more important than the current market price. The P/E ratio is driven by market perception and the forces of demand and supply, which becomes less impactful if our EPS is already high. However, the best outcome is when a high, growing EPS is combined with a high P/E!