The Price-to-Earnings Ratio
I often talk about a stock’s P/E or price-to-earnings ratio in my articles for ETR. While P/E may be one of the most common ways of evaluating a stock, its interpretation can be difficult for novice investors – especially since all P/E ratios are not calculated the same way. Here is some basic information to help you understand what it means:
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Some analysts calculate a stock’s current P/E ratio by using the past six months of the company’s earnings (net income from continuous operations found in the income statement) and the estimated earnings of the next six months.
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Those who use the “trailing P/E” ratio, work with the past 12 months (often designated as “TTM” or Trailing Twelve Months) of actual earnings. You’ll typically see this ratio used on the Yahoo! Finance stock screener.
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The “forward P/E” ratio is typically based on the estimated earnings for the next 12-month period. Although it is not as reliable as the current or past P/E data, it nonetheless gives you an idea of the expectations of a company’s potential growth.
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Historically, 15 has been the average P/E ratio. If a stock has a P/E of less than 15, this may indicate that it is undervalued. Above 15, and you may be getting less than your money’s worth. Find a P/E in the single digits and there’s a good chance that you’re looking at one heck of a bargain-priced stock with an upside that can earn you a nice profit.
Keep in mind that there is much more to a stock investment than P/E ratios … but they are a good place to start.
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