P/E Ratio

[primer]

I understand how it's calculated and what it represents, but I'm still not positive on how the affects the outlook of a company's stock price. In other words, what do you look for when considering taking a position in stock? What does a high/low P/E ratio signify?

I've also heard that one should not use price multiples as the only measurement when looking at a stock.

[netwrangler]

Originally Posted by primer

I understand how it's calculated and what it represents, but I'm still not positive on how the affects the outlook of a company's stock price. In other words, what do you look for when considering taking a position in stock? What does a high/low P/E ratio signify?

I've also heard that one should not use price multiples as the only measurement when looking at a stock.

Hi Primer,

Some thoughts on PE ratios:
Quite literally, the PE ratio is what the market is willing to pay for the current earnings of a company.

When a stock has a PE that is higher than average, it is often a "growth" stock. The market believes earnings for the company will grow at a higher rate than average, and that this justifies a higher PE ratio. However, popular, or "fad" stocks tend to have high PEs as well and these may or may not be justified.

When a stock has a PE ratio that is lower than average, it may be considered a "value" stock. But there are many other reasons for a low PE. For instance, energy stocks often have lower than average PEs during periods of high energy prices because the market doesn't believe the high energy prices will last. Also, a low PE may be a sign of other problems—pending lawsuits, for example.

The PE for, say, the S&P 500 as a whole gives you something you can use to compare with the PE of individual stocks. Also, this market PE gives you a measure of the overall optimism in the market. In a bull market, the average PE will tend to rise. At some point, the bull market will end [or correct] and the average PE will fall.

When I look at a stock, I always look at the PE. No matter what it is, high or low, I ask myself whether the PE seems appropriate. If the PE is far away from the average [more than 50% away] I want to know why. If I can't find a reason, I tend to avoid the stock - something is going on that I haven't figured out.

That's just a start. I'm sure others can add to this. In the meantime I'll try to find some references that will help you gain a deeper understanding of this key stock ratio.

[Albert0373]

I only look at the PE if I'm adding a stock to my long term portfolio, you really have no need for it otherwise. Take for example...FSLR

Trading with a PE of 179.66, yet broke out nicely from its inverted head and shoulders pattern on the charts and spurted up 50% in two months.
It had a high PE already, back when it was $30. Up 413% since I first started trading it (I've been in and out so I didn't get that much )

See, "relatively high multiples do not necessarily mean their stocks are over priced and not good buys for the long term." A P/E ratio uses past earnings so it'll give a less accurate reflection of the growth potentials. The PEG ratio is better to use in determining growth:

PEG = (P/E) / Growth

PEG: <1 = UNDERVALUED
PEG: >1 = GROWTH
PEG: >2 = OVERVALUED

More on the PEG, and why it's better than using the PE to compare growth:
http://www.investopedia.com/articles/00/092200.asp

Great article on Investopedia to help you:
"Is a stock with a lower P/E always a better investment than a stock with a higher one?"
http://www.investopedia.com/ask/answ...nvestments.asp

[netwrangler]

Originally Posted by netwrangler

Hi Primer,

Some thoughts on PE ratios:

...[see above for full quote...]

That's just a start. I'm sure others can add to this. In the meantime I'll try to find some references that will help you gain a deeper understanding of this key stock ratio.

My first thoughts, staying on the PE as per your question.

Originally Posted by Albert0373

I only look at the PE if I'm adding a stock to my long term portfolio, you really have no need for it otherwise. Take for example...FSLR

Trading with a PE of 179.66, yet broke out nicely from its inverted head and shoulders pattern on the charts and spurted up 50% in two months.
It had a high PE already, back when it was $30. Up 413% since I first started trading it (I've been in and out so I didn't get that much )

See, "relatively high multiples do not necessarily mean their stocks are over priced and not good buys for the long term." A P/E ratio uses past earnings so it'll give a less accurate reflection of the growth potentials. The PEG ratio is better to use in determining growth:


More on the PEG, and why it's better than using the PE to compare growth:
http://www.investopedia.com/articles/00/092200.asp

Great article on Investopedia to help you:
"Is a stock with a lower P/E always a better investment than a stock with a higher one?"
http://www.investopedia.com/ask/answ...nvestments.asp

Excellent addition from Albert on PEG. I use PEG often, but Albert explains it much better than I could have. Gives link references too.

Originally Posted by BuyOnDips

They have a nice balance sheet. They have a nice looking chart. They just reported this morning and easily beat estimates and raised guidance. It looks like a winner to me.

http://finance.yahoo.com/q?s=CBI

http://www.marketwatch.com/News/Stor...yhoo&dist=yhoo

Here's an opportunity to apply some of this PE and PEG knowledge in an analysis.
The fun part of this forum is putting the pieces together and coming up with something useful.

BTW: I'll reply to BuyOnDips' post in that thread.
Assume you know you can jump to there by clicking the little blue arrow at the end of the first line of BuyOnDips' quote.

[primer]

Thanks for that, both of you. I'm starting to get comfortable with it.