After finding the price of a particular stock, usually the next number everyone looks at is the P/E ratio.
P/E is the ratio of a company's share price to its per-share earnings.
A P/E ratio of 10 means that the company has 1 of annual, per-share earnings for every 10 in share price. (Earnings by definition are after all taxes etc.)
A company's P/E ratio is computed by dividing the current market price of one share of a company's stock by that company's per-share earnings. A company's per-share earnings are simply the company's after-tax profit divided by number of outstanding shares. A company that earned 5M last year, with a million shares outstanding, had earnings per share of 5. If that company's stock currently sells for 50/share, it has a P/E of 10. At this price, investors are willing to pay 10 for every 1 of last year's earnings.
P/Es are traditionally computed with trailing earnings (earnings from the past 12 months, called a trailing P/E) but are sometimes computed with leading earnings (earnings projected for the upcoming 12-month period, called a leading P/E).
For the most part, a high P/E means high projected earnings in the future. But actually the P/E ratio doesn't tell a whole lot, but it's useful to compare the P/E ratios of other companies in the same industry, or to the market in general, or against the company's own historical P/E ratios.
Some analysts will exclude one-time gains or losses from a quarterly earnings report when computing this figure, others will include it. Adding to the confusion is the possibility of a late earnings report from a company; computation of a trailing P/E based on incomplete data is rather tricky. (It's misleading, but that doesn't stop the brokerage houses from reporting something.) Even worse, some methods use so-called negative earnings (i.e., losses) to compute a negative P/E, while other methods define the P/E of a loss-making company to be zero. Worst of all, it's usually next to impossible to discover the method used to generate a particular P/E figure, chart, or report.
Like other indicators, P/E is best viewed over time, looking for a trend. A company with a steadily increasing P/E is being viewed by the investors as becoming more speculative. And of course a company's P/E ratio changes every day as the stock price fluctuates.
The P/E ratio is commonly used as a tool for determining the value of a stock. A lot can be said about this little number, but in short, companies expected to grow and have higher earnings in the future should have a higher P/E than companies in decline.
For example, if a company has a lot of products in the pipeline, I wouldn't mind paying a large multiple of its current earnings to buy the stock. It will have a large P/E. I am expecting it to grow quickly. A rule of thumb is that a company's P/E ratio should be approximately equal to that company's growth rate.
PE is a much better comparison of the value of a stock than the price. A 10 stock with a PE of 40 is much more "expensive" than a 100 stock with a PE of 6. You are paying more for the 10 stock's future earnings stream. The 10 stock is probably a small company with an exciting product with few competitors. The 100 stock is probably pretty staid - maybe a buggy whip manufacturer.
It's difficult to say whether a particular P/E is high or low, but there are a number of factors you should consider!
First: It's useful to look at the forward and historical earnings growth rate. (If a company has been growing at 10% per year over the past five years but has a P/E ratio of 75, then conventional wisdom would say that the shares are expensive.)
Second: It's important to consider the P/E ratio for the industry sector. (Food products companies will probably have very different P/E ratios than high-tech ones.)
Finally: A stock could have a high trailing-year P/E ratio, but if the earnings rise, at the end of the year it will have a low P/E after the new earnings report is released.
Thus a stock with a low P/E ratio can accurately be said to be cheap only if the future-earnings P/E is low.
If the trailing P/E is low, investors may be running from the stock and driving its price down, which only makes the stock look cheap.
Ioannis - Evangelos C. Haramis was born in Greece in 1951 and he studied in Greece, USA and in Belgium. He has been active in the stock markets since 1972. Since 2002 he is New Business Development Managing Director at an Investment Bank and the publisher of http://www.greekshares.com/
Copyright ? 2005 I.E.C. Haramis
What does it mean to short a stock?This means that... Read More
Economists know more about how the fragments of society work... Read More
"There is nothing more frightful than ignorance in action!" Johann... Read More
Picture one of those clubs where only the real heavyweights... Read More
Many people would like to diversify their portfolios to expand... Read More
The trash business in its efforts to cook their books... Read More
Spread trading is a technique that can be used to... Read More
Someday you may want to retire and continue to live... Read More
Three little pigs went to the market to stock up... Read More
The date October 13, 2000 will forever be embedded in... Read More
Everyone who invests in the stock market wants to be... Read More
Forget making a profit; instead focus on the income provided... Read More
Its dinnertime and the phone rings. It's Joe Noname with... Read More
When is a dividend not a dividend?The latest thing "conservative"... Read More
At some time in your life you have been on... Read More
You read and hear a lot about hedge funds. Unfortunately,... Read More
In one of my previous articles (Investing in the stock... Read More
The demand for world oil is increasing while world reserves... Read More
The basis of diminishing return discussions surround such simple notions;... Read More
There are red lights, green lights, blue lights and spot... Read More
With over 6,000 mutual funds available, it may be tempting... Read More
Checked your 401K lately? Going back to about a year... Read More
As an investor you will want to check out any... Read More
Well, not really. What I mean is I don't mind... Read More
The Shadow knows. There used to be a radio program... Read More
Recently I was invited to appear on a live CNNfn... Read More
With over 6,000 mutual funds available, it may be tempting... Read More
Suppose your position has made a big move and you... Read More
When is a dividend not a dividend?The latest thing "conservative"... Read More
A PEG ratio cannot be used alone but is a... Read More
A recent cartoon in my daily newspaper showed two guys... Read More
Dollar cost averaging is one of the most popular ideas... Read More
With all the bad news that has been dumped upon... Read More
Unfortunately, most of you who are reading my column are... Read More
Four blind men were asked to give a description of... Read More
What is leverage?Here is a definition of leverage from an... Read More
There is a current movie entitled "Eternal Sunshine of the... Read More
Today's society gives special recognition to alcoholics, sexaholics, binge-aholics, shopaholics,... Read More
TOO OFTEN, INVESTORS SIMPLY CHOOSE TO follow the crowd. This... Read More
What are you thinking when it comes to your no... Read More
There has been great condemnation recently because China has been... Read More
Most people think the stock market is a zero sum... Read More
Options trading can increase the profits you make when trading... Read More
One of the great truisms of Wall Street is "Don't... Read More
Let's first define insanity. It is doing the same thing... Read More
Let's go into the details of why non-indexed mutual funds... Read More
Two weeks ago I wrote about what the Securities and... Read More
You remember (they show it on TV every year) the... Read More
Wall Street's watchword has always been diversification, but what does... Read More
According to Investopedia Inc. the penny stock market has seen... Read More
Stocks & Mutual Fund |