PE Ratio
Have you seen the PE Ratio on all the investment sites, but wondered what is meant. It is the price to earnings ratio. The figure was popularized by legend Benjamin Graham. It is a way to find relative value.
How to Calculate PE Ratio
Take the stock price and divide that by the earnings per share. For example, a stock price of 100 and earnings per share of 10 would give you a PE Ratio of 10 (100/10=10).
For Example
Take two companies that both are selling at $20.00 dollars per share. They both cost the same to purchase, but the values may be quite different. If company A has 10 dollars per share of earnings and company B has 2 dollars of earnings per share, then company A has much more value than company B. Incidentally the PE Ratios would be 2 (company A) and 10 (company B). You can see from this example, that lower PE Ratios indicate better values.
PE Trends
You need to keep in mind that PE Ratios have historical value. You should expect certain kinds of stocks to consistently trade in a PE Range. If all the stocks start to pull out of the historical ranges, then you know a bubble is coming and you will need to formulate an exit strategy. You should be very careful when PE Ratios are above the historical norms. How do you know the historical norms. Do some research before investing. Most investment sites have the data you need.
Sector PE Ratios
Certain sectors or industry types have similar PE Ratios. If you compare ten or twenty companies, you can see quickly the best value by looking at the PE Ratios. The lowest PE Ratio has the most value. Technology companies will typically have a lot higher PE Ratio than Commodity Companies. It doesn't mean to stay out of technology. What that means is to compare the PE Ratio against the sector benchmark you have determined from doing your research.
Once you determine a low PE Ratio, the next step is to find out if there are other good fundamentals going on. You want that ratio to increase so that you can make some money.
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