I was studying our company stock and it has a p/e ratio of almost 40. I see other similar companies at around 15 -20.
Can someone simply explain how to best utilize a p/e ratio to determain if a stock is overvalued?
I was studying our company stock and it has a p/e ratio of almost 40. I see other similar companies at around 15 -20.
Can someone simply explain how to best utilize a p/e ratio to determain if a stock is overvalued?
There is no absolute rule. However, a p/e that is twice as high as similar companies is a warning that the stock may be overvalued. You have to know a lot about the company, its business, its competitors, investor psychology, economic trends. It also helps to know how to read tea leaves, bones, chicken entrails (i.e. there ain’t no guarantees).
What FranticMad said.
P/E (price-to-earning) ratios are, in isolation, not a good stock indicator of future price. At the very least, you need to look at the P/E ratios of your immediate competitors and of the entire sector.
(Very) Generally speaking, a P/E of 40 is rather high, and usually indicates a growth or overvalued company. The S&P 500 index is currently around 18 (as of December 2002, 19.42; 28.06 including negatives, per .Barra
If your company has a P/E higher than “similar” companies, and you do NOT believe it has signficantly higher growth prosepects than these other companies, then stay away. But look very closely at the “E” to make sure it doesn’t have some unusual components (one oddly good quarter, or one big write-off).
Most analysists, though, will tell you that P/E is a good way to screen a large number of stocks to get at a smaller number of them that you want to investigate further, but that ratio alone is a very poor guide to picking stocks.
Agreeing with the earlier comments, but adding a note that you should bear in mind that the “E” in a P/E ratio refers to historical earnings, while the price of a stock typically reflects the marketplace consensus estimate of future earnings. That’s why you’ll often hear news items such as “Company XYZ announced earnings last quarter above expectations, but its price declined because it forecast lower earnings in the next quarter”.
Just so I make sure I am understanding the p/e ratio right.
The ratio represents the number of years it would take to earn back your inital investment if condition never changed (of course we know they do)
Let’s say Mark-Mart has a p/e ratio of 10. Current stock price is 35.00 and I divided that price by the company earning for the last 12 months, say in this case it was $3.50 a share so 35/3.50 is 10.
So let’s say I bought 100 shares at 3.50 or 3500. So 100 shares would earn 350 a year and in 10 years I would earn back my 3500. So 10 is the p/e ratio. Is this correct logic?
I was reading some historical highs included McDonald’s in 1972 had a p/e ratio of 50. And Electronic Data Systems had a p/e ration of 500 in the mid '60s.
Is it strictly a comparison of the same industry to the same industry. For instance how do you compare ABC Disney to CBS Viacom. Both are TV companies but both have a lot of other industries.
Close, the ratio is price to (historial) earnings, not dividends. The ratio of dividend to price is called the yield, usually expressed as a %.
So a company may have a low PE (or high earnings per share) but elect to retain (re-invest) the magority of earnings and you get a low dividend.