Through-cycle average earnings that strip away cyclical distortions — the contrarian's tool for identifying businesses that appear expensive on current earnings but cheap on normalised earnings.
Deeper Explanation
In a cyclical trough, reported earnings are depressed and P/E ratios appear inflated — the opposite of the business's through-cycle economics. A mining company reporting ₹1 EPS in a commodity downturn (up from normalised ₹10 EPS) appears to trade at 50x earnings at a ₹50 share price. On normalised earnings it trades at 5x — extraordinarily cheap. Dreman's research showed that buying the lowest-P/E stocks in cyclical industries at trough conditions produced exceptional returns as earnings normalised. The skill is distinguishing cyclical troughs (temporary, warranting contrarian buying) from structural decline (permanent, warranting avoidance even at low multiples).
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