Explaining the P/E Ratio in Stocks
For example, let's say XYZ Corp is trading at $20.00 per share (current stock price) and their EPS is $2.00 per share. By doing the simple division here, we see that the P/E Ratio of XYZ Corp is 10. So what does P/E Ratio signify?
The P/E Ratio signifies exactly how much you are spending for every dollar of earnings that the company achieves. In our XYZ Corp example, you would be spending $10.00 for every $1.00 of earnings that the company has. Basically, if a stock has a high P/E, it is considered to be overvalued and if it has a low P/E, it is considered to be undervalued.
Of course these rules are not hard and fast, but there are many investment professionals who swear by the P/E. As for what constitutes a high P/E versus a low P/E, that number too will vary. I was taught that any P/E under 20 was a good investment and to stay away from stocks that had a P/E of 21 or more. While this served me well when I was a stock broker, again, it was not always an indication of a safe bet or a bet to avoid.
A natural question that I would often get is, "What if a company has no earnings?" If this is the case then a stock will have no P/E as there is no way to do the calculation. Besides, if a company is not making any money, then don't you think that it is only a matter of time before they go under?
You can ask your financial advisor more about what the P/E of a stock means to your portfolio, but don't be surprised if their numbers are different from mine. As stated earlier, I learned about P/E Ratios one way and that is why my numbers are based on 20, but that is not always going to be consistent. What will be consistent though is the fact that the P/E Ratio remains one of the oldest tools used to measure the attractiveness of investing in a certain common stock.
Source: Investopedia, P/E Ratio Introduction, Investopedia.com
Published by Jimmy Collins - Featured Contributor in Business & Finance
Full time freelance writer. I am a former stock broker and money manager who still loves all aspects of finance as well as sports and fitness. Currently I hold a 4th degree black belt in the Martial Art of T... View profile
- How Starbucks Conquered the WorldA case study of the biggest coffee store in the globe.
- The Women's Civil Rights Revolution and the Downfall of Nazi-FeministsModern feminism today can be completely different than what is shown on television. In my paper, I delve into the downfall of modern feminism, or what I like to call Nazi-feminists.
- A History and Overview of the Statement of Cash FlowsIn 1987, the U.S. Federal Accounting Standards Board added the Statement of Cash Flows to its required framework for all publicly-traded companies. Learn what comprises the Statement of Cash Flows and read about the d...
- LLCs and the Federal Income TaxFor U.S. federal income tax purposes, a Limited Liability Company (LLC) could be treated as a sole proprietorship, a partnership, or a corporation, depending on the number of members and the election that is made
- United Technologies: The Reality of GreedThe United Technologies layoffs are just another ugly demonstration of corporate greed and the overuse of the company term restructuring.
- Exactly What Does the PE Ratio of a Stock Really Mean?
- How Many Stocks Are Necessary to Be Properly Diversified?
- Five Ideas to Hedge a Declining Market with High Yield Dividend Stocks
- Is the Price to Earnings Ratio Outdated?
- An Investment Analysis of Apple Inc
- And the Poor Continued On
- Reports that the US Dollar is Dying Are Premature
5 Comments
Post a CommentNicely done, Cheers. :)
i have been wanting to get into the market for a couple years now... thank you for all the lessons and tips!!! you are going to make it that much easier for me to keep my money!!! lol
thanks for the lesson :)
Thank you for explaining the P/E.
Thank you for explaining the P/E.