1998: What makes a company’s price-earnings ratio move up relative to other companies?

AUDIENCE MEMBER: Thanks for the beautiful — beautiful weekend in Omaha. I’m Mike Asale (PH) from New York City, with a question for Warren and Charlie about what makes a company’s price-earnings ratio move up relative to other companies in its industry.

How can we, as investors, find companies, and even industries, that will grow their relative price-earnings ratios as well as their earnings?

And thank you for the wonderful weekend and for sharing your brilliance with the shareholders.

WARREN BUFFETT: Oh, thank you.

AUDIENCE MEMBER: Thank you. (Applause)

WARREN BUFFETT: You know, it’s very simple, the price-earnings ratio — relative price-earnings ratios — move up because people expect either the industry or the company’s prospects to be better relative to all other securities than they have been — than their proceeding view. And that can turn out to be justified or otherwise.

Absolute price-earnings ratios move up in respect to the earning power — or the prospective earning power of — that is viewed by the investing public of future returns on equity, and also in response to changes in interest rates.

And in the recent — well really, ever since 1982, but accentuated in recent years, you’ve had decreasing interest rates pushing up stocks, in aggregate.

And you’ve had an increase in corporate profits. Return on equity of American businesses improved dramatically recently. And that also — and people are starting to believe it, so that has pushed up absolute price-earnings ratios.

And then within that universe of all stocks, when people get more enthusiastic about a specific business or a specific industry, they will push up the relative P/E ratio for that stock or industry.