Intro to PE, Price-to-Earnings Ratio

Discussion in 'Educational videos and material' started by StockJock-e, Apr 18, 2016.

  1. StockJock-e

    StockJock-e Brew Master
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    Welcome student!

    Let Khan academy guide you through PE ratios!

     
  2. Bodacious

    Bodacious Active Member

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    Price/Earnings
    By acquiring shares of a particular company, we become its shareholders. When its market value increases, share price also increases, and vice versa, when the company loses its value, its shares become cheaper. Buying shares of any company only makes sense if we assume that it will grow and will be increasing its profits. The company may pay dividends to its shareholders, but not if it decides to reinvest all earned money. In both cases, profits are strength of the company and the indicator discussed today refers to them.

    P/E or Price/Earnings is nothing else than the current price of the company shares divided by its Earnings per Share (EPS). Therefore, if P/E is 10, it means that investors are willing to pay 10 USD for every 1 USD profit generated by the company. How on the P/E basis can we determine whether given share are currently undervalued (cheap) or overvalued (expensive)?

    First of all, we can refer to market indices. For example, if we look at historical P/E for the S&P 500 index consisting of 500 largest companies listed on the New York Stock Exchange (see chart), we note that the price/earnings ratio ranged from 6 in 1948, up to 120 during the 2008 Great Financial Crisis . When we find an average, then it turns out that for the U.S. it is about 15 and this level is usually considered neutral in the United States. Accordingly, all companies with P/E lower than 15 are treated as undervalued and those with higher P/E are overvalued.

    Please read the entire article at:
    https://independenttrader.org/how-to-use-price-to-earnings-ratio.html
     
  3. Bodacious

    Bodacious Active Member

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    Summary
    Price/Earnings is very popular indicator used in fundamental analysis. There is a reason for that - it is clear and simple to calculate. It refers to the actual state of an asset and allows us to quickly determine whether we are dealing with market/company that is expensive or cheap, yielding profits or losses.

    P/E also has drawbacks but only some of them are included in this article. It is worth to note that the indicator does not take into account company's debt, or that profits disclosed by the company may be falsified. There are more examples and the devil is always in the details. Therefore, to avoid mistakes, one must never rely solely on one indicator. Fundamental analysis without considering debt levels, operating margins, dividends etc. will always be imperfect.
     
  4. Onepoint272

    Onepoint272 2019 Stockaholics Contest Winner

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    Khan does a great job. One thing he did not point out though, is that the P/E ratio is the number of years it would take a company to double your investment if the earnings stayed constant. So with a PE of 10 it would take 10 years to earn the amount of the investment and with a PE of 20 it would take 20 years and 20 years to double money is not a great return. Using the rule of 72, doubling money in 20 years gives an annualized return of only 3.6% which might only keep up with inflation.
     
  5. AbbeyMayward

    AbbeyMayward New Member

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    I never thought to check on Khan for these things. Thank you for sharing!
     
    Bodacious likes this.

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