You have the multiple for the company you're dealing with, you have a historical benchmark, you have a cross-sectional benchmark, and let's take may be either one of those two. The next question that you need to ask is, why there may be a difference. We know that the P/E ratio of Marriott is 39, and we know that in the past it was lower and that of competitors right now is lower. Does that mean anything? Does that mean that Marriott's expensive and therefore that we shouldn't buy? Well, not necessarily. That's where step number 2, which is absolutely critical, comes in, and step number 2 is asking the question, why is that the case? Can I explain the difference with fundamentals, because if I conclude that people are willing to pay more for Marriott than they did in the past, or they're willing to pay more for Marriott than to the competitors today, then maybe it is because Marriott is expected to grow more than it did in the past, or than the competitors are expected to grow today, or maybe because Marriott is less risky than it was in the past, or that the competitors are today. We need to ask the question. We need to look at the fundamentals to see whether there's any way to explain that difference because if there is, actually if we can explain why people may want to pay more for Marriott than for the competitors or for Marriott today than for Marriott in the past. If we can explain that with fundamentals, then that means that there's no trading opportunity, meaning that there's no reason to buy yourself. Marriott is priced more aggressively than other companies, Marriott is priced more aggressively than it was in the past simply because it's a better company, it's expected to grow more, or it's less risky, or whatever are the fundamentals that you find and therefore there is no trading opportunity. Now, of course, it may be the case that you look at expected growth, you look at risk, you look at other fundamentals, and you cannot explain why people are paying so much for Marriott compared to what they did in the past or compared to the competitors, well, then there may be a trading opportunity. Then maybe you can conclude that Marriott is expensive and therefore you shouldn't buy it or maybe you should even short sell it and it's important to keep that in mind. Step number 1 without step number 2 doesn't mean anything at all. Here the real work comes in step number 2. Step number 1, it's a little bit, I wouldn't call it trivial, but finding benchmarks to compare your P/E ratio with, and that's not too difficult. Making something out of the comparison, that's where the difficulty really come. Now, when you look at those fundamentals and we can talk for a very long time about this and this is what analysts really do, there's two that you may begin with. One is expected growth and the other is risk. There's a way we can rewrite the P/E ratio. You may or may not have seen this expression before. Don't get scared at that and that basically says that the P/E ratio can be expressed as a function of the relationship between dividends and earnings, that the D/E, that's what we call the dividend payout ratio. The proportion of earnings that is paid out as dividends and then growth, the g, that is the expected growth of dividends, which you can think of in the long-term as the expected growth of earnings and R basically stands for the required return on equity and remember that required return always depends on risk. The important point about that expression is that we can re-express, we can think of P/E ratios as a function of the expected growth of the company, and the higher the expected growth, the more you'd be willing to pay and function of the risk of the company, and of course, the riskier the company, everything else equal, the less you'd be willing to pay. That'll be the ideal starting point for asking that second step or for going through that second step and asking the question, is there any way to explain the difference between the multiple that I'm using and the fundamentals that I'm exploring.
