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I'm here to finally tell what in the world a P/E Ratio is
and why it matters to you. No, a P/E ratio has nothing to do with high school
physical education or how many pull-ups you can do but it can help tell you
when you might be overpaying for a stock.
What Is a P/E Ratio?
Last time, we talked about ratios and how they can help you
compare companies and select the best stock out of a bunch. The P/E Ratio is just one of the more
important ratios that can tell you a lot about a company's earnings and value.
The "P" in the P/E stands for "Price" and the "E"
stands for Earnings. The "P" is the easiest to find - pull up a quote
from any vendor and you'll know exactly what the price of the company's stock
is trading at right now.
You'll often hear the term "P/E Ratio" thrown
about on TV when different talking heads are chatting about their favorite
stocks. In fact, it can be an clever insult to tell an analyst that you think
his favorite stock's P/E Ratio is too high! You may also hear it by its other name
"Price Multiple" or even "Earnings Multiple." Any of those
names fit, but they all mean the same thing.
Calculating P/E Ratios
So how do you get this all-important number? The P/E Ratio
often listed right on the main page of any stock you pull-up from your favorite
stock website like Yahoo Finance, Google Finance, or MSN Money. You can find it
where it says "P forward slash E" and it's usually a relatively low
number. For example, right now, Microsoft (MSFT) has a P/E Ratio of 12.30, with
it's stock trading right now at $21.50 per share and an Earnings per Share
value of $1.75. In comparison, Apple (AAPL) has a current P/E ratio of 25.0, as
its stock is trading right now just above $140 with Earnings Per Share at
$5.568. It's not enough to look at the current price of a stock and determine
how expensive it really is.
To calculate P/E yourself, just take the current stock price
and divide that by the earnings per share, or value after "EPS."
Sometimes you'll see "F P/E" which stands for Forward Price to Earnings
Ratio, which is just a best-guess of what the company's earnings per share will
be into the future. To calculate P/E yourself, just take the current stock
price and divide that by the earnings per share, or value after
"EPS."
Why Should You Care About the P/E Ratio?
Why should you care about how high or low a company's P/E
Ratio is? You can use the P/E Ratio to judge whether a stock might be cheap or
expensive. But be careful - a low P/E does not necessarily mean a stock is
cheap just like a high P/E doesn't mean a stock is expensive! Don't fall into
this trap! You have to compare apples to apples! You have to put a stock's P/E
ratio into the proper context. For example, many 'high-flying' technology
stocks such as Google (GOOG) - which has a current P/E Ratio of 31 - will
almost always have higher P/E ratios than stocks in other industries, like the
auto industry or or retail industry. At the same time Google's P/E Ratio is
almost 30, Wal-mart (WMT)'s ratio is only 14.95 - almost 15. In comparison to Wal-Mart,
Target stores (TGT) has a P/E Ratio of 14.83 - very close to Wal-Mart which is
what we would expect.
Now you can start putting stocks into context and comparing
them at a deeper level than just their price alone. Stay tuned for the next
time we start explainingmore about PE Ratios and how you can scan to find and
compare PE Ratios and so much faster!
This is Andrew Horowitz and thanks for joining me today.
Remember, if you really want to make more money and stop from losing on bad
bets, stick around as we discuss tips and tricks to help make you a winning
investor.
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