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
one time home cleaning Highland Park ..I know there are a lot of you out there... Read More
If you are fed up with early redemption charges and... Read More
I have watched my cat play with a bag of... Read More
The Dow Theorycharles h. dowcharles h.... Read More
As a novice trader, you'll often feel the need to... Read More
A recent cartoon in my daily newspaper showed two guys... Read More
Much like the middle child, mid-cap stocks have long struggled... Read More
Economists know more about how the fragments of society work... Read More
You have decided to buy some stock or mutual funds,... Read More
Money management starts with protecting your capital, realizing profits and... Read More
Ever have one of those sample boxes of candy? Each... Read More
I often play a little game with myself when I... Read More
If you're a normal human being, your need to feel... Read More
Unfortunately, most of you who are reading my column are... Read More
Let's say you are interested in this one company. You... Read More
As GuruFocus updates the stock buys and sells of gurus,... Read More
The gleam and bright lights of Wall Street lure in... Read More
We need a rabbit!This was a pretty horrible week for... Read More
During the day I watch CNBC-TV, the stock market channel.... Read More
It is difficult to make money in a bull market,... Read More
The ABC's of Stock Trading SuccessStock trading success...why is it... Read More
What! Me worry?Many of you remember the cover of MAD... Read More
Now where have I heard that before? I know. It... Read More
Why? Because I am going to shatter your conventional wisdom... Read More
You have a lock on your house. You have a... Read More
licensed cleaning services Park Ridge ..04/28/2005NASDAQ dropped -12.5% year to date in 2005. S&P500 index... Read More
It is difficult to make money in a bull market,... Read More
Investors who exclusively use broadly diversified, no load mutual funds... Read More
Quick, look out the window. It's raining. No, the sun's... Read More
The broker told me not to sell because the mutual... Read More
You read and hear a lot about hedge funds. Unfortunately,... Read More
Recently I was invited to appear on a live CNNfn... Read More
After some forty years of banking and investments, I retired... Read More
Index Fund Trading can be one of the most profitable...or... Read More
Ever have one of those sample boxes of candy? Each... Read More
In 1960 an engineer working for a watch company in... Read More
Investing in long-term financial vehicles give you the most gains... Read More
Two weeks ago I wrote about what the Securities and... Read More
What does it take to be a stock trader? It... Read More
When most analysts, financial planners, fund specialists and investors try... Read More
How often have you come across an advertisement or e-mail... Read More
One of the basic laws of physics states that a... Read More
Maximizing a stock market investmentThere are several factors an investor... Read More
Because there are so many stocks that are NOT paying... Read More
I am taking the time to help others learn the... Read More
If you have not back tested your trading system, you... Read More
You'd have had to be living on a desert island... Read More
The stock market often closes a week in the middle... Read More
What is the Series 7 Exam? If you... Read More
Reduce your investing and stock market risks by:Setting your sights... Read More
Stocks & Mutual Fund |