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Easy Investing with PE Ratio

The PE Ratio (also know as P/E and PER) is a fundamental indicator of how well a stock is doing compared to its earnings. “P” stands for Price, and “E” stands for Earnings, so basically it’s the stock price to annual earnings ratio. It can also be looked at as a way for investors to understand how in demand the current stock is. Higher PE ratios usually indicate more volatility in the stock price, as investors are currently paying a premium for the stock with the expectation the stock price will continue to produce healthy returns. On the other hand, a relatively low PE can potentially mean the stock is currently on sale as investors do not expect high returns. So how does the individual investor use the PE ratio to analyze a stock?

There are several suggested methods for using the PE ratio as a fundamental indicator in the value of a stock. One method is to find the average PE ratio across the stock industry. For example, if you are researching biotechnology companies, stock screening and research sites usually provide the industry average PE ratio. If the stock under research has a PE ratio lower than the average industry PE, it may signal a good buy.

Some investors use the PE ratio calculation with the forward looking earnings value. By dividing the stock price of one share by the future yearly earnings expectation, you can determine the forward looking PE Ratio. If the value is lower than the industry average, this can also strongly suggest the stock may be at a prime purchase point.  The reason is that the stock is discounted based on the future earnings, and if the stock hits its future earnings, its price should rise to the industry average, resulting in a healthy stock price appreciation.

Now that you know what the PE Ratio is and how it’s used, have fun searching through stocks to find which ones stick out as exceptional discount prices. Most stock screen sites and stock search pages allow you to search and sort by PE Ratio.

Please note that PE Ratio should not be the only indicator or piece of information used to make decisions on stock purchases. It is however one of the most fundamental indicators used by stock analysts when researching stocks, and should be used as one component when deciding which stocks are best to buy.

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