Market-Based Financial Ratio:Price Earning Ratio

June 9th, 2006 Comments off
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PRICE EARNINGS RATIO (P/E) :

FORMULA

Market Price per Share of Common Stock / Earnings Per Share.

MEASURE WHAT

Evaluates the relative attractiveness of a company’s stock price. One of the quickest and easiest ways to determine if a stock is trading on an investment or speculative basis.

SCORE/VALUE

Different industries-different P/E ranges- technologies sell at 40 P/E while textile at 8 P/E.

Varies due to different expectations for different businesses ; tech stocks sell higher because expect a much higher growth rate and earn high returns on equity while textile mill dismal margin & low growth prospects which will then trade at a much smaller P/E multiple.

SALIENT POINTS TO NOTE

Over priced when the average P/E ratio of all of the companies in the industry/sector is far above the historical average. E.g. dot-com frenzy of the late 1990’s. Thus the investors could have avoided the hugh declines in the technology stocks by selling the stocks when realizing the entire industry was dangerous expensive.

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Financial Accounting

 
 

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