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P/E Ratio
Date Added: September 1st, 2005
Article provided by Alex Weis
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In today's market, value investing is as extinct as inflationary pressures. Most investors are taking risks by investing in companies with PE ratios greater than 100. Let me elaborate on what a PE ratio is and what its uses are. PE ratio stands for Price-to-Earnings ratio. One obtains a company's PE ratio by dividing the stock's price by its earnings per share.
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Let's look at the PE ratio of some companies and analyze what its value means. Yahoo!, a well known Internet company, has a PE ratio of 1760. By traditional market standards, this value is astronomically high. In today's technological age, though, this value is not necessarily regarded as high because many investors are predicting that Yahoo! will grow substantially higher. Lets look at a more traditional company such as IBM. IBM has a PE ratio of 30. This value is sixty times lower than Yahoo's PE ratio. Let's find out why this is the case. IBM is an older, more established company. Its growth is not quite as near as high as Yahoo's. Therefore, investors are not willing to pay inflated prices for IBM stock.
Companies that belong to slow growth industries often have low PE ratios. A good example is the Banking Industry. Two major banking firms, Banc One and First Union have PE ratios of 10 and 11 respectively. This is attributed to the slow growth attained in their industry and to rising interest rates.
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Now that we know what a PE ratio is let's see how it can be used to make money! If a company has high growth and its PE ratio is low (a PE ratio is considered to be low when it is near or lower than 20), then it is considered to be an undervalued stock. Its almost like going to a store and paying twenty dollars for a shirt you know is worth fifty dollars. Eventually, if the company keeps attaining its high growth and low valuations then the market will find out about it and the stocks price will hopefully appreciate. This is the principle I and many investors utilize when buying stocks.
A good example is given by a stock that I own. When I first bought it, it was selling for 4.75 dollars a share and it had a PE ratio of about 15. I waited patiently for some time (as every wise investor should) and the company announced an important deal with another corporation. Now the stock rose from about 5 to a high of 17. Even though the stock rose initially because of their announcement, what kept its momentum was its low valuations. All that is required for this type of investing is a healthy amount of research and patience.
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Another Great Site!
Be sure to head over to TeenAnalyst for lots of great investment articles!
TeenAnalyst.com
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PEG Ratio
For people who want to measure a company a little better, this ratio will help you determine if a stock is a good buy
Corporate Earnings
Companies report their earnings in EPS. This is plugged into the PE ratio formula.
Fund Classifications
Learn about the different types of fund classifications and objectives…
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