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MARKET LEARNINGIf you're new to investing and trying to learn, you probably see a lot of common phrases.
The one I want to focus on today is "Price-to-Earnings Ratio".
It shows up a lot and is worth understanding.
Let's dig in without getting too in the weeds.
The Price-to-Earnings Ratio (P/E Ration, P/E, PER) is the ratio between a company's share price and its Earnings Per Share (EPS).
What's EPS?
EPS is simply the company's profit divided by the number of shares outstanding.
Company X: $100 profit / 100 shares = $1.00 EPS
What's EPS?
EPS is simply the company's profit divided by the number of shares outstanding.
Company X: $100 profit / 100 shares = $1.00 EPS
So, let's say Company X has a share price of $10/share.
To calculate the P/E Ratio, we divided the share price, by the EPS.
$10 / $1 = 10
The P/E Ratio for Company X is 10 (often shown as "10x").
So, we know how to calculate it, but why do we need to know it at all?
To calculate the P/E Ratio, we divided the share price, by the EPS.
$10 / $1 = 10
The P/E Ratio for Company X is 10 (often shown as "10x").
So, we know how to calculate it, but why do we need to know it at all?
The P/E Ratio basically tells us, that we are investing $10 for every $1 of annual earnings
Put differently, if we purchase one share of Company X, it will take 10 years to recoup our investment (if everything remained constant).
So what should we look for?
Put differently, if we purchase one share of Company X, it will take 10 years to recoup our investment (if everything remained constant).
So what should we look for?
A higher P/E means that investors are willing to pay a higher share price, because they believe the company is growing quickly.
On the flip side, a higher P/E may indicate that a company is overvalued if it's not growing quickly enough.
High P/E does not always equal growth.
On the flip side, a higher P/E may indicate that a company is overvalued if it's not growing quickly enough.
High P/E does not always equal growth.
A lower P/E could mean one of two things:
- Investors don't want to pay for a company they believe isn't growing or is at risk of not making money.
or
- The stock is undervalued because the price is low in relation to it's earnings.
This is where the value investors enter.
- Investors don't want to pay for a company they believe isn't growing or is at risk of not making money.
or
- The stock is undervalued because the price is low in relation to it's earnings.
This is where the value investors enter.
Any interpretation of the P/E Ratio should be done against the backdrop of the company & the market as a whole.
Do not rely solely on the P/E to make your investment decisions.
Hopefully this cleared it up some.
If not, reach out in my DMs, I may or may not explain it better.
Do not rely solely on the P/E to make your investment decisions.
Hopefully this cleared it up some.
If not, reach out in my DMs, I may or may not explain it better.
Finally, if this was of any value to you and you would like to learn more about investing...
I would direct you to my eBook "Baby Steps to Investing".
It's a beginner's guide that will give you the confidence to get started.
BUY IT HERE FOR $5 https://gum.co/djWbi
I would direct you to my eBook "Baby Steps to Investing".
It's a beginner's guide that will give you the confidence to get started.
BUY IT HERE FOR $5 https://gum.co/djWbi
