Ratio Review: What is a ratio? A relationship between two quantities, normally expressed as the quotient of one divided by the other: The ratio of 9 to 7 is written 9:7 or 9/7.
Stock Review Stock is ownership in a company. The price of the stock is constantly changing. Each year a company reports on how much it earns that year on a share of stock.
Price to Earnings RatioTo figure out the Price to Earnings Ratio, divide the price of a stock, by the earnings per share. Price of a stock Earnings per share
Computing P/E Ratios: 1st we need to know the price of the stock. 2nd we need to know the annual earnings per share. 3rd we divide the price of the stock by the earnings.
Example: Apple (AAPL) Researching on the Internet we can find the annual earnings per share of Apple. It was $5.72 in October of 2009. Source - finance.yahoo.com The price of Apple stock changes, which means the price to earnings ratio will continually change.
What Else? What happens to the Price to Earnings Ratios if only: The Stock Price Goes Higher? The P/E ratio goes higher. The Stock Price Goes Lower? The P/E ratio goes lower. The Earnings Go Higher? The P/E ratio goes lower. The Earnings Go Lower? The P/E ratio goes higher.
Understanding the Ratio What does a high P/E ratio mean? The stock price may be over-valued or the company is growing rapidly. What does a low P/E ratio mean? The stock price may be under-valued or the company is in a mature industry.
Understanding the Ratio Would you buy a stock with a high or low P/E ratio? “Stocks with higher forecast earnings growth will usually have a higher P/E, and those expected to have lower earnings growth will in most cases have a lower P/E.” “Investors can use the P/E ratio to compare the value of stocks: if one stock has a P/E twice that of another stock, all things being equal (especially the earnings growth rate), it is a less attractive investment. Companies are rarely equal, however, and comparisons between industries, companies, and time periods may be misleading.” – Source http://en.wikipedia.org/wiki/P/E_ratio