3 Smart P/E Ratio Indicators
Business

3 Smart P/E Ratio Indicators

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3 Smart P/E Ratio Indicators.  The P/E Ratio is derived from a company’s stock price and the earnings per share.  This ratio levels the playing field for all stocks, even of different prices and earning levels.  In this post we are distilling down 3 smart P/E ratio indicators.  For more information on choosing profitable stocks have a look at these (5 simple ways to pick a stock).

The P/E Ratio is a long time popular stock indicator with years of algebraic formulas and many, many studies behind it.  The P/E Ration is simple and not rocket science, but this ratio has spawned decades of scientific research.  One might say the P/E ratio is like the First born child of stock indicators and here is why.

Even prior to the 1960s – that is 60 years – scholars have been using algebra and all sorts of acronyms to utilize the powerful information the PE Ratio can indicate.  Suffice it to say the benefits of the P/E Ratio are powerful in helping to determine both the viability and vitality of a stock.

 This ratio levels the playing field for all stocks, even of different prices and earning levels.  In this post we are distilling down 3 smart PE ratio indicators.
Checking the Stock Price.

PE Example:

If our Widget sector’s average P/E is 13.

  • Bravo has a P/E = 13
  • Zulu has a P/E = 27
  • Company Bravo is considered to be less expensive despite having a higher price than Company Zulu.  You see with Company Bravo you will pay less for every $1 of existing earnings.  That being said, Company Zulu has a higher ratio than both the sector and the competing Company Bravo. We may draw the conclusion that when investors look to the future they will be expecting higher earnings growth compared to the market.

The P/E ratio is helpful and provides valuable insight but it is just one of the many valuation indicators and financial analysis tools that we use when choosing an investment option.

  1. Number 9

One could say that the number 9 as a P/E ratio is the dividing line.  Maybe it’s the benchmark from where we can see on one side, the risk of buying a stock.  On the higher side the P/E ratio value shows us the earning growth expectations of investors.

In fact, the higher P/E number reflects the confidence that the price of the stock is going to rise (bringing the P/E ratio back to 9).  One might say that P/E ratio when it less than 9 the company may be a under-valued.  On this lower side of 9, company Bravo trades lower compared to its fundamentals.  On the down side of being below a P/E ratio of 9 this could be viewed as a sign of risk.  There is a reason the price is lower and there is not an expectation of greater short-term future growth.  Likely, the price can drop to bring the ratio back to the benchmark of 9.

  1. Compare companies

One can use the P/E ratio to consider the price connection to earnings and what the buyer is willing to pay.  Take our two companies, Bravo and Zulu. One could consider a multitude of factors like debt, workforce size, business cycle, and industry sector.  However, when the P/E ratio in considered all these other variables are second when the connection of the stock price and earnings are connected and seen as so valuable. We can compare companies based solely on the value of the stock.

  1. Compare a company to its sector

When we compare both Bravo and Zulu to their Widget sector we can see that there is greater earnings expectations for Zulu as opposed to Bravo. One can see how a particular company compares to the business sector as a whole. Using the P/E ratio in this way shows how your stock choice ranks against its industry peers.

https://finviz.com/groups.ashx?g=sector&v=120&o=pe

Conclusion:

A PE Ratio is an important valuation tool that can give key insights into whether a stock may be over or undervalued.

 

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